NOVEMBER 25, 2020

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By Lewis Braham

Like bad indie rock, most mutual funds labeled”alternative”haven’t aged well.

The average fund in Morningstar’s multialternative category—a group that is supposed to justify an average expense ratio of 1.8% by weathering tough times the way hedge funds do—has a 15-year annual-ized return of just 2.5%. That isn’t a strong selling point, considering the S&P 500 has returned 9.4% and U.S. bonds have come in at 4.5% over the same period.

One notable exception: the $2.9 billion BlackRock Systematic Multi-Strategy fund (ticker: BAMBX). It has posted an average annual return of 5.4% for the past five years, outpacing the 2.3% for the average multialternative fund. And its expense ratio is below average at 1.22%, while most brokers waive its 4% load.

Equally important, BlackRock Systemat-ic behaves like a truly defensive hedge. The fund is less than half as volatile as the 60% stock/40% bond Morningstar Moderate Target Risk benchmark. Its worst three-month loss in the past five years was 2.9%, compared with the benchmark’s 13.4%. It has also held up especially well compared with the broader market: During that five-year period, it has seen 23% of the S&P 500’s returns during up periods, and, most critically, only 2% of its downside during negative periods—outperforming its cate-gory average both in good and bad times.

The fund is the brainchild of lead manager Tom Parker, 62, who in 2001 joined Barclays Global Investors—which BlackRock (BLK) acquired in 2009—to build quantitative investment strategies for bonds. That proved far trickier to do than for stocks—bonds have many thousands of

issues that don’t trade on central exchanges with easily accessible or analyzable pricing data like stocks. “We were pioneers in the field,” Parker says. He began managing his first quantitative bond hedge fund in 2004 and now oversees about $80 billion as chief investment officer of BlackRock’s quant-driven Systematic Fixed Income group.

Parker saw plenty of problems to fix when it came to retail alternative mutual funds. If they invested in fixed income, most tended to put too much in low-qual-

ity, high-yield bonds, which are far more correlated with stocks in down markets than high-quality bonds, he says. That led to multialternative funds’ poor upside/downside capture ratios—in the past five years, they captured 23% of the S&P 500’s monthly upside but 38% of its downside. Moreover, most of these funds tended to use stocks as the main portion of their port-folio, but with limited hedging that would help protect against unexpected declines.

This fund largely flips that recipe on its head. Half of the fund is in a more tradi-

A $2.9B Alternative Fund That Actually Works

MUTUAL FUND PROFILE

Tom Parker, left, and Jeff Rosenberg co-manage the $2.9 billion BlackRock Systematic Multi-Strategy fund. Illustration by Ryan Melgar

Co Managers, BlackRock Systematic Multi Strategy

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tional high-quality fixed-income portfolio, what Parker and his two co-managers, Jeff Rosenberg and Scott Radell, call the “di-rectional asset allocation” portion because it typically moves with broader markets. This part of the fund is the most straight-forward. It relies on various fixed-income securities to generate returns, mostly high-quality corporate, government, and mortgage bonds, but occasionally high-yield bonds. So, for instance, one of the fund’s quantitative models that adjusts the portfolio’s directional exposure based on macroeconomic factors started to increase its high-yield debt weightings after the U.S. government began its massive stimulus programs in March to help the weakest companies. The fund’s high-yield allocation grew from 10% in March to 15% in October.

The fund’s stocks, which are tradition-ally more volatile, act as the ballast for the portfolio. The stock portion employs a market-neutral strategy that balances long positions—bets a stock will rise—against short positions—bets a stock price will fall. The returns of this so-called defensive eq-uity long/short strategy “tend to be highest when equity markets are going down,” Rosenberg says.

That is because the defensive strategy’s hundreds of short bets are against weak, highly-leveraged companies—like Macy’s (M) and Nordstrom (JWN)—the shares of which typically fall more than the overall market during declines. The fund also buys many stocks of highly leveraged compa-nies—but only those with businesses that are strong enough to pay their debts, like Home Depot (HD) and Lowe’s (LOW). These companies tend to do well in cyclical upturns, when investors think the economy is back on track and debts can be repaid.

This split approach takes advantage of the fact that companies with high debt loads have the greatest “dispersion” in re-turns, Parker says. In other words, the best of these companies perform very different-ly from the worst—whereas the stocks of low-debt companies move much more in lockstep. BlackRock’s research shows that such performance dispersion is amplified in volatile down markets, meaning the worst overleveraged companies do very poorly then—and the fund’s short bets pay off. As a result, historically, this defensive strategy has gained 0.16% for every 1% monthly decline in the S&P 500.

Buying those high-debt companies’

shares instead of the traditional high-qual-ity, low-debt defensive stocks prevents the long-short strategy from getting whip-sawed during a post-decline recovery. (High-quality companies hold up better in down markets, but often lag during recov-ery rallies.) Thus, the fund’s correlation has been 29% with the S&P 500 during down months, but 62% during rising markets.

If all of this sounds complicated, that’s because it is. Thankfully, the three co-man-agers have access to a deep team of 51 BlackRock investment personnel working on the three underlying strategies, as well as the computing technology of the world’s largest asset manager to crunch the num-bers for the fund’s quantitative analysis.

The third sleeve of the fund’s strategy is a macroeconomic one that primarily consists of long and short bets on different countries’ debt. As it does with the long-short equity strategy, the Systematic team is looking to hedge out the market-based factors that swing securities’ returns one way or the other. But they still want to maintain the unique qualities of individual bonds they favor—or those they dislike—to maximize the difference in returns between the two sides of the portfolio. “When peo-ple generally talk about macro investing, they’re talking about big directional ex-posures on currencies and interest rates,” says Rosenberg. “If there is a headline about this fund, it’s the value of dispersion over direction.”

In this portion of the fund, the team currently holds Italian bonds, which have better yields than French bonds, which they are betting against. Both bonds are from European countries and denominat-ed in euros—market-based factors that Parker and Rosenberg seek to eliminate via hedging. With the large investment team they have helping them, they tend to do that well.

Please see the accompanying fact sheet for standardized returns and portfolio information as of the most recent calendar quarter. The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. All returns assume reinvestment of all dividend and capital gain distributions. Refer to blackrock.com for current month-end performance. You should consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and, if available, the summary prospectus contain this and other information about the fund, and are available, along with information on other BlackRock funds by calling 800-882-0052 or from your financial professional. The prospectus and, if available, the summary prospectus should be read carefully before investing. Reprinted with permission of Dow Jones, December 2020. The opinions expressed in this reprint are intended to provide insight or education and are not intended as individual investment advice. We do not represent that this information is accurate and complete, and it should not be relied upon as such. USRRMH1220U/S-1437571

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