2 Absolute Return Mutual Funds To Enhance And Protect A Strategy
In the past we’ve looked at using a tactical overlay, gold, and commodities to improve an asset allocation strategy. Now we’ll look at the advantages of a 10% allocation to a Long/Short fund and a 10% allocation to a Market Neutral fund to consider their roles in constructing and managing an asset allocation strategy.
First the Vanguard Market Neutral Fund (VMNFX) which has been around since November 1998.
Here is the correlation of the fund against the Vanguard 500 Index Investor fund (VFINX). Market Cycle I (Blue): October 2007 – September 2014, Market Cycle II (Red): August 2000 – October 2007.
Overall the Vanguard Market Neutral fund had low correlation to domestic large caps in both cycles and particularly in the 1st stage downtrend of a cycle. Therefore it has good potential as an alternative allocation in the context of an overall strategy.
The next chart illustrates the advantage of a 10% allocation to the Vanguard Market Neutral fund on the basis of cumulative growth utilizing Vanguard domestic index funds for comparison strategy purposes.
Base Strategy-
Alternative Strategy-
- 45% Large (VFINX), 9% Small/Mid (NAESX/VIMSX)
- 36% Intermediate Bond (VBIIX)
- 10% Vanguard Market Neutral (VMNFX)
The chart illustrates a market neutral advantage (Alternative Strategy – Base Strategy) of cumulative growth in the 1st stage downtrend of a cycle as the 10% allocation acts to protect the portfolio. In both cycles, we can see greater overall asset growth reach as high as 4% with the Alternative Strategy.
In the 2nd stage uptrend, the results were mixed …. it continued to add to cumulative growth in Cycle II and acted as a drag in Cycle I.
Next we are looking at a fund which has improved cumulative asset growth in both stages of a market cycle … the Robeco Boston Partners L/S Equity Inv (BPLEX) acts to enhance an asset allocation strategy.
As you can see in the most recent cycle it was highly correlated to domestic large caps in Cycle I and less so in Cycle II.
The next chart illustrates the cumulative growth comparison and the advantage of a 10% allocation to the Robeco Long/Short.
Base Strategy-
- 50% Large (VFINX), 10% Small/Mid (NAESX/VIMSX)
- 40% Intermediate Bond (VBIIX)
Alternative Strategy-
- 45% Large (VFINX), 9% Small/Mid (NAESX/VIMSX)
- 36% Intermediate Bond (VBIIX)
- 10% Robeco Long/Short (BPLEX)
The Long/Short allocation improved asset growth over a majority of both cycles with Alternative Strategy asset growth hitting as high as 6-7% more than the Base Strategy.
What do I see?
1) The Vanguard Market Neutral fund has the potential to be a great protector during a downtrend in stocks and may be just the allocation needed to replace a core allocation to both stocks and fixed-income if you are concerned about a combination potential of a drop in stocks and a pop in interest rates.
2) The Robeco Long/Short has had some remarkable performance and may even be a candidate for a core domestic large cap allocation for more aggressive investors. However the performance comes at a price (2.68% net expense ratio).
Disclosure: None.