For most of us, investments fall into two simple categories: stocks or bonds.
Some investors are adding an “other” category in their search for possibly safer or better returns. They’re pouring into what the industry calls alternative funds, which are generally bringing hedge-fund-like strategies to the masses. It’s still a niche corner of the market, but nearly $13 billion flowed into alternative funds in the past year, according to Morningstar.
Still, there’s confusion about what these funds do and whether they’re worth the costs they charge over more straightforward index funds. The Gateway fund is one of the largest and oldest alternative funds in the market. Managers Mike Buckius and Paul Stewart recently discussed their fund’s strategy. They invest in stocks, like a traditional stock fund, but they also buy and sell options, which they use to steady returns. Answers have been edited for clarity and length.
Q: What’s the broad objective of the fund?
Buckius: We own stocks because they go up most of the time, and we do some things on the management side to smooth the ride out. We’re trying to get a decent amount of the return with a lot less of the risk. That means we have smaller losses in downturns and shorter recovery periods. In bull markets, we tend to lag, but we still have positive returns.
Q: You’ve historically generated about two-thirds of the S&P 500’s returns, but with milder swings. Wouldn’t a diversified portfolio, in which bonds balance out the risk of stocks, be similar?
Stewart: The thing is that the 10-year Treasury yield is hovering around 2 percent (about half what it was a decade ago). It’s very difficult, nearly impossible, for the bond market to replicate the returns they had over the last 10 years.
Buckius: We’re not investing in bonds, but the problem we’re trying to address is: How do I manage the risk of my equity portfolio the way bonds have historically done?
Q: So the people coming into your fund are moving money that had been in bonds? Or are they selling stocks instead?
Buckius: I think a little bit of each. People in our fund are a little more on the conservative side, or they’re older and they don’t have the time to accept a three-, five- or seven-year time horizon to recover their losses from a bear market.
Q: Is there a wrong reason to get into a fund like yours?
Buckius: If you think a market crash is coming. We’re there to cushion that, but we’re not betting against the market. We expect the market to go up over a long period of time. We just don’t want to ride the roller coaster.
Q: So much focus recently has been on keeping fees low. Your fees are maybe triple what an S&P 500 index fund charges.
Stewart: Yes, it’s more expensive than an index fund. There’s no denying that. But I would submit we’re doing a lot more work than an index manager.
Q: How much of a portfolio should be in alternatives?
Buckius: We see people having anywhere from 10 to 20 percent either in us or in a portfolio of two or three alternatives. The thought process behind that is you want to have enough to make a difference, but you still want to have exposure to traditional asset classes.
