Thanks to the upcoming U.S. elections, Deutsche Bank woes, Fed rate hike dilemma and stretched valuations, October is likely to be a highly volatile month. Market volatility threatens the one thing that everybody holds dear – money. Hence, to hedge such risks it will be prudent to invest in alternative mutual funds.
Volatility to Spike in October
With the presidential elections just around the corner, the month of October is expected to face heightened turbulence. The CBOE Volatility Index (VIX), a gauge of near-term investor anxiety, has always risen from the month of September to October, except for 1996, when Bill Clinton handily won the re-elections.
More uncertainty looms large this month as Deutsche Bank’s woes continue to spook investors. Shares of the lender plunged more than 50% this year as investors remain worried about the institution’s thin capital cushion. Such a decline affected other European banks, already plagued by Eurozone’s weak economy and negative interest rates.
September jobs data is due on Oct 7. The outcome can also help shape market perception in the coming weeks. A December rate hike is more likely, but, if the jobs data turn out to be mediocre like the August one, it might indicate that the domestic economy is in a tight spot. The market is already in a precarious situation, as most analysts warn that stock market valuations are at elevated levels. This makes the market more vulnerable to a volatile sell-off (read more: 5 Best Stocks for a Scary October).
How to Navigate this Volatility?
Investing in alternative mutual funds is the best way to play this volatility. These funds mostly include long/short equity funds, market-neutral funds and trading-leveraged equity funds. These types of funds are available to investors of all income levels and provide that extra edge brought in by diversity. Let us now discuss these three types of funds in some details.
Long/Short Mutual Funds
Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the current market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued.
It profits from shorting the overvalued stocks and buying the undervalued stocks. Weights are subject to change and are dependent on management’s view regarding the market.
Market-Neutral Mutual Funds
Market-neutral funds aim to adopt a precision approach by shorting 50% of their assets and holding 50% long. This approach seeks to identify pairs of assets whose price movements are related. The fund goes long on the outperforming asset and shorts the underperformer.
A market-neutral fund is designed to provide stable returns at relatively lower levels of risk regardless of market direction. This is particularly relevant in today’s highly volatile scenario when the objective is to protect the capital invested.
Trading-Leveraged Equity Funds
Leveraged funds use borrowed money to increase returns in a short spell of time. These funds generally strive to return a certain multiple of the short-term returns of an equity index. Leveraged funds are primarily marked “ultra”, “bull” or “2X”.
Leveraged funds also offer benefits such as diversification. These funds invest in a diversified portfolio of assets which minimize risk, while escalating returns. In addition to this, investors enjoy the benefits of “dollar cost averaging,” where a young investor depositing $10,000 in these funds reaps the same benefits a high net worth individual receives, say by depositing $50,000,000. These funds also enjoy tax deductions.
4 Best Alternative Mutual Funds for Your Portfolio
As mentioned above, alternative mutual funds are such new product classes that are equipped to protect investors’ portfolio and provide steady returns amid market volatility. Thus, we have selected four such alternative mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive 3-year and 5-year annualized returns, minimum initial investments within $5000 and carry a low expense ratio.
The question here is why should investors consider mutual funds? Reduced transaction costs and diversification of portfolios without the several commission charges that are associated with stock purchases are the primary reasons why investors should park their money in mutual funds (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).
JPMorgan Multi-Cap Market Neutral A (OGNAX - MF report) attempts to neutralize exposure to general domestic market risk by investing in common stocks that the fund’s adviser considers to be attractive and ‘short selling’ stocks that the adviser considers to be unattractive. OGNAX’s 3-year and 5-year annualized returns are 0.7% and 0.4%, respectively. Annual expense ratio of 1.27% is below the category average of 1.58%. OGNAX has a Zacks Mutual Fund Rank #2.
Aberdeen Equity Long-Short A (MLSAX - MF report) invests the majority of its assets in equity securities of companies that are organized under the laws of or have their principal securities trading market in the United States. The fund’s 3-year and 5-year annualized returns are 1.5% and 3.8%, respectively. Annual expense ratio of 1.56% is below the category average of 2%. MLSAX has a Zacks Mutual Fund Rank #2.
Glenmede Long/Short (GTAPX - MF report) invests a major portion of its assets in long and short positions with respect to equity securities, such as common stocks, of U.S. public companies. GTAPX’s 3-year and 5-year annualized returns are 3.2% and 6.1%, respectively. Annual expense ratio of 1.16% is below the category average of 2%. The fund has a Zacks Mutual Fund Rank #1.
ProFunds UltraSector Health Care Investor (HCPIX - MF report) invests in securities and derivatives that the adviser believes, in combination, should have similar daily return characteristics as one and one-half times (1.5x) the daily return of the Dow Jones U.S. Health CareSM Index. The fund’s 3-year and 5-year annualized returns are 18.2% and 28.4%, respectively. Annual expense ratio of 1.61% is below the category average of 1.84%. HCPIX has a Zacks Mutual Fund Rank #2.
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