Which alternative funds performed well in the market rout?

As equities and bond markets tumbled in tandem in the first half of the year, many alternative funds struggled along with them.

Scotiabank’s Alternative Mutual Fund index of 61 Canadian liquid alternative funds was down by 4.5% at the end of June. That was a gentler ride than investors found in broad indexes, though, with the S&P/TSX Composite down by 13.9% for the same period and the S&P 500 down by almost 20%.

There were also some standout performers among liquid alts, with certain leveraged and inverse products taking advantage of the market environment, and other defensive funds performing as expected during a broad selloff.

According to figures provided by Fundata, 10 Canadian alternative mutual funds had double-digit returns for the first half of the year, and another seven returned between 5% and 10%. (This tally doesn’t include passive inverse and leveraged products, some of which did extremely well leveraging energy indexes or with inverse exposure to broad indexes.)

Five of the top performers were from Horizons ETFs Management (Canada) Inc., with the firm’s BetaPro Inverse Bitcoin ETF up by 91.5% at the end of June, per Fundata, as the price of Bitcoin collapsed. (The fund dropped by 25% last month and was up by 42% for the year as of July 31, according to Horizons.)

The manufacturer’s natural gas and crude oil ETFs were also up more than 36% in the first half, per Fundata.

However, those products aren’t long-term investments to include in most client portfolios.

“The problem with a lot of alternatives is they tend to be binary,” said Mark Noble, executive vice-president of ETF strategy with Horizons. Some funds have either long or short positions, while others have full exposure to one volatile sector.

“While inverse Bitcoin has been an incredibly successful strategy, the risk factor on that is off the charts,” Noble said, adding that pure natural gas and oil products are also extremely volatile.

Another fund, the Horizons ReSolve Adaptive Asset Allocation ETF, performed well in the first half but is designed to generate returns in all market conditions. The fund returned 7.2% through the end of June, per Fundata.

The fund is diversified more than standard stock-bond or long-short equities strategies, Noble said, as certain triggers prompt it to short bonds, for example, or to overweight commodities.

“Those things allowed it to generate positive returns in otherwise negative market conditions for stocks and bonds,” he said.

Another fund that performed well in the first half was the AGFiQ US Market Neutral Anti-Beta CAD-Hedged ETF, with a 22% return through June, per Fundata. The fund is designed to protect investors from large drawdowns in U.S. equities, as occurred in the first half of this year.

The fund invests in long positions in low-beta U.S. equities and shorts high-beta names, such as the long-duration growth stocks that are most negatively impacted by rising interest rates.

“It’s very useful for investors because there are very consistent market environments where the fund will do well,” said Bill DeRoche, chief investment officer at AGF Investments LLC and head of AGFiQ Alternative Strategies. “And there are other environments where it will do poorly.”

With fixed income performance as poor as it was in the first half and traditional 60-40 funds getting killed, DeRoche said, the ETF proved to be an especially good risk-mitigating tool. It could continue to be a substitute for fixed income if rates keep rising, he said.

Equities and bonds have rebounded since the end of June, but DeRoche said he expects more volatility before we return to a risk-on environment. Interest rates still need to rise to get inflation under control, but many investors have started to price in a recession and interest rate cuts.

“I think that everybody’s missing an intermediary step,” he said.

However, DeRoche said investors will want to reduce exposure to the fund when the rate cuts happen. “When we do go risk on, because of the negative beta, you would expect the fund to underperform like we’ve seen historically.”

Other top-performing liquid alt funds in the first half included the Fidelity Global Value Long-Short Fund, which seeks to exploit value stock mispricing and was up by 42.2%, per Fundata, and Arrow Capital Inc.’s Wavefront Global Diversified Investment Class (series A), up by 28.9%.