Money managers aren't the only ones talking about goals-oriented investment strategies, the wirehouses are doing it, too. And Morgan Stanley Wealth Management
's Lisa Shalett
is using the framework as a way to plug alternatives into clients' investment strategies.
In a recent white paper
, entitled "An Outcomes-Oriented Approach to Alternatives," Shalett, who is head of Investment and Portfolio Solutions at Morgan Stanley, outlined the history of alternative investments, particularly hedge funds, and how they've gone from being private, exclusive vehicles for select investors, like institutions and very wealthy people, and becoming more available, via mutual funds, to the general public.
They are also being thought of more as an instrument in the portfolio to achieve a specific goal, like lower volatility, diversification, risk mitigation, downside protection or higher returns, but not all of the above.
"In our view, investors today need to improve returns and reduce volatility, and alternatives, including hedged strategies, are once again a possible solution. Unlike in previous periods, alternatives in the form of mutual funds and ETFs are more accessible to an even broader group of investors," Shalett wrote in the white paper.
Shalett also broke down clients' potential investment goals in the white paper, the alternative strategies that would fit those goals and their return potential, annual volatility and correlation.
If a client's goal is capital preservation, for instance, the role of alts would be inflation protection and real asset strategies, like commodities, precious metals/gold, master limited partnerships and global real estate investment trusts, could be used.
Equity market neutral and relative value, including credit long/short strats, could be used for real return enhancement/preservation, when the goal is income.
A balanced growth goal could utilize equity global macro, managed futures, and hedge funds of funds or multi strategy alternatives to manage volatility, while equity long/short and event-driven strategies can be tapped to diversify a stock portfolio, if the goal is market growth.
Alternative managers often bemoan the fact that giving up "the illiquidity premium," and putting '40 Act constrictions on funds will result in diluting returns, but in her paper Shalett also outlined the strategies that are affected most and least by the illiquidity premium and noted that its role only affects private equity and real estate strategies highly. For most other alt strats, the role is medium or low (for more details see page 11 of the white paper).
Shalett also recently spoke with MFWire
about portfolio construction and what Morgan Stanley looks for in alts managers. Here are some of the tid bits she had to share:
Shalett said Morgan Stanley recommends investing 10-20 percent of a client's portfolio, depending on their goals, in alternatives. "As we move into an environment where interest rates start rising, we will probably recommend that they fund those allocations from fixed-income," she said. In other stages in the market cycle, they'd recommend clients pull the money from equities.
On Track Records
At Morgan Stanley, there are two levels of due diligence. "One is for a fund to be available for sale to our clients directly and the second is to be included as part of the advisory programs," Shalett said. For the advisory platform, the firm usually does require a three-year track record in the fund. Though when it comes to alts strategies, where there has been a track record in place that's auditable in a comparable strategy and run by a team that has been together for a while, Morgan Stanley could waive the requirement. "We have made a handful of exceptions there," Shalett said.
On Manager Selection
"I think the fundamental issue is to separate the wheat from the chaff," Shalett said. "It's about finding teams that are razor focused on what their benchmarks truly are," she added. Morgan Stanley is wary of peer group indices, like the HFRX or HFRI, which track hedge funds as a whole without regards to strategy. "These are not relevant to our clients," she said. At Morgan Stanley, "We've suggested very plain benchmarks," she added. Depending on the strategy, this can be a few percentage points over LIBOR, Treasury bills or the S&P 500, and are also outlined in the white paper.
"We're looking for managers who can demonstrate that they have a tightly managed process for keeping their strategy within clearly defined zones, that they do what they say they do, that they have a process for managing correlation," Shalett said. "We also look at how they are managing daily liquidity, what are their processes for doing that? Are they paying attention to liquidity-oriented risks?"
On Client Education
When it comes to retail investors adopting alts, "It continues to be early days," Shalett said. The firm's executives have been traveling throughout the country and sharing information about the strategies. "There is a lot of enthusiasm, not just because our industry likes innovation but because the problems that clients have to solve have become so complex, given the opportunity set," she said. "So the question is: what do you do? how do you live? With an eye toward generating returns in retirement. People are being driven to look at these products out of necessity."
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