With interest rates still low, the advisor hunt for yield and investment alpha seems never ending. A variety of specialized funds may provide a solution. In their own ways, these funds seek to capture some of the strategies of risky, volatile investments, such as hedge funds or futures contracts, without being as risky or volatile.

The funds are no miracle cure – some advisors object to the relatively high fees or complexity. And one of the strategies relies on volatility (either up or down) to generate gains, meaning periods of relative quiet produce poor outcomes.

Might they be a fit in your clients’ portfolios? Learn more below.


Advisors who want to take advantage of some of the trading strategies of hedge funds without some of the risk might want to consider long-short funds. Long-short funds use leverage, derivatives and short positions on equities, fixed-income or alternative investments in an attempt to maximize total returns.

Investors can generate income via some long-short funds in the form of annual or semi-annual dividends, but the funds are most commonly used as a diversification tool in hopes of lowering portfolio volatility. Pimco EqS Long/Short Fund, which returned 4.83% year-to-date as of March 20, paid an annual dividend in December of roughly six cents a share.

Long-short funds generally have better terms than hedge funds, but they typically have higher fees and less liquidity than most mutual funds. They’ll also often require sizable minimum investments.

For some, those fees can be deal-breakers. “The expense ratio for these types of funds commonly is greater than 2% or even 3%,” says Gary Sidder, president of Life Transition Planners in Littleton, Colo. “That becomes a big hurdle to make the total return attractive enough to use these funds.”

For others, long-short funds have become a useful tool. The funds represent the middle of a portfolio, in between stocks and bonds, says Thomas Forester, chief investment officer at Forester Capital Management in Lake Forest, Ill. They have less volatility than stocks and more return than bonds, especially with 10-year

Treasurys yielding around 2%. If clients are looking for return but don’t want the volatility of equities, Forester says, long-short funds can be “phenomenal candidates.”

His firm’s long-short fund is a hedged equity fund. While the fund manager doesn’t technically short, his team uses puts to limit the downside risk of the securities portfolio.

Forester says long-short funds tend not to be correlated to the market. “If one thinks the market is going to the sky, then they’ll want as much beta as they possibly can get,” he says. “If an advisor is bullish, this is not a good category for them. But if an advisor has clients nearing retirement age who would like some return but little downside risk, then long-short funds would be a good fit for them.”


Advisors hoping to bolster the momentum in their clients’ portfolios and get a small income component may want to consider managed futures funds.

These funds buy and sell futures contracts on a wide variety of commodities and financial instruments, including currency futures, Treasury bonds, index futures and certificates of deposit. The funds’ portfolio managers aim to capitalize upon the momentum in pricing trends for these contracts.

Income comes in the form of annual or semi-annual dividends. For example, the State Street/Ramius Managed Futures Strategy Fund, which returned 26.56% over the past year as of March 20, in December paid an annual dividend of 94 cents.

But a momentum strategy can be difficult to explain to clients, leaving some advisors to conclude that the funds aren’t a good fit. “If my clients cannot adequately explain back to me what they are investing in, I shy away from those products and approaches,” says Ronsey Chawla, an advisor at Per Stirling Capital Management in Austin, Texas.

But managed futures funds have often done well when other approaches fail. “Whenever the markets go up or down, there is momentum, and managed futures funds can make money in either market as long as it’s trending,” says Josh Charney, an alternative investment analyst at Morningstar. “In fact, in the 2008 financial crisis, managed futures funds made money.”

That being said, some managed futures funds have struggled during the past couple of years, Charney says. “Although equity markets have been trending, momentum in other markets, such as commodities or currencies, has been harder to come by,” Charney notes. “Equity markets, too, have had some notable head fakes over the last few years.”

Harriet J. Brackey, director of investments at GSK Wealth Advisors in Hollywood, Fla., uses managed futures funds rather than playing in the futures markets. “We don’t try to pick whether corn will be doing better than soybean, because we don’t have a clue, and we don’t even try to have a clue,” Brackey says.

“But Treasuries frighten us because they’re just going to drop in value when interest rates rise.”

Edward Walters, head of products, research and retirement plan services at Janney Montgomery Scott in Philadelphia, says managed futures funds are also good diversifiers, because they have had little historical correlation to stocks and bonds. “In market downturns, managed future funds can be portfolio stabilizers, reducing portfolio volatility,” Walter says. “However, it’s still important to determine clients’ comfort levels with these types of strategies.”


Conceived and launched by a number of companies just as the financial crisis hit in 2008, managed payout funds can be thought of as a cross between a mutual fund and an annuity, and may be suitable for clients who require a steady stream of income without the commitment of an annuity.

The one big caveat: Unlike annuity products, managed payout funds do not provide guaranteed lifetime income.

Managed payout funds are essentially mutual funds that make annual, quarterly, or even monthly distributions. They’ve been performing better since the economy started picking up in 2012. Annual returns among the 22 managed-payout funds identified by Morningstar averaged just 0.5% in 2011, but rose to 10.2% in 2012 and 10.9% in 2013. In 2014, total returns averaged 4.94%. Fidelity’s Income Replacement 2042 Fund, as one example, pays monthly: roughly 3 cents per share in December, 3 cents in January, and 4 cents in February.

Managed payout funds haven’t attracted a lot of attention due to a combination of issues, says Kevin J. Meehan, advisor and regional president of Wealth Enhancement in Itasca, Ill. Investors and their advisors who are seeking income in the current low-interest rate environment have a tendency to look first at familiar strategies, such as fixed-income bond funds and dividend-paying stocks and annuities. “There is not as much consumer recognition with managed payout funds as there is with these other instruments,” Meehan says. As the market continues to recover, as managed futures funds perform better, and as more baby boomers retire, Meehan says demand could increase.

“Managed payout funds could have the potential to add liquidity for people who need cash, as there are consistent outflows every month,” says Morningstar's Charney. “Moreover, it’s an alternative fund, so its principal is not going to go up or lose as much as the overall market. It’s a lower risk, lower return strategy.

But these funds shouldn’t be the only funds in their portfolio, and there are not that many out there.”
Ashley O’Kurley, a financial planner at Signator Investors in Miami, warns that managed payout funds may not be sufficiently flexible for some clients. “By definition, mutual funds offer the same formula for everybody in the fund, even though everybody’s income needs are very individualized,” O'Kurley says. “A client may need to buy a truck in year five and then want to go on a cruise in year seven, so their income needs are going to vary from year to year.”

Katie Kuehner-Hebert is a freelance writer in Running Springs, Calif. She has contributed to Financial Planning, On Wall Street and American Banker.

Read more:

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access