Portfolio Construction and Management
Certain strategies in the Alternative Strategies Fund and High Income Alternatives Fund use derivatives and/or shorting. Most short selling is done in the Alternative Strategies Fund by equity-oriented managers as part of the normal course of merger-arbitrage (owning the target company and shorting the acquiring company), or as part of a pair trade, where a manager owns a stock and shorts one or more closely related stocks in order to hedge industry risk. Managers may also short stocks as part of “stub” trades, where they are long a conglomerate or holding company, and short one or more publicly traded subsidiaries in order to isolate the undervaluation of the remaining company. There are typically a limited number of very small directional short equity positions where the manager is betting against a stock. Managers may at time use options as hedges around specific events, primarily for hedging.
Derivatives, in the form of credit default swaps (CDS) and interest rate swaps or futures, are used by two credit-oriented managers for hedging credit and interest rate risk, respectively. Additionally, one of those managers (DCI) uses CDS to gain long and short credit exposure to a diversified group of individual companies as a core part of their overall strategy. Loomis Sayles also uses currency forwards to hedge currency risk in non-USD positions, as well as for expressing (typically modest) directional views on other currencies.
The managers of the equity funds can short stocks though it is highly unlikely that they will do so. The funds can also transact in derivatives though the only derivatives transactions expected to be part of any of the funds’ ongoing strategy are foreign currency futures contracts for the sole purpose of hedging currency exposure when foreign stocks are held. Even in this case, it is unlikely that most foreign currency exposure will be hedged. In the case of Litman Gregory Masters Funds International Fund, some of the managers do not hedge their currencies while others will hedge, depending on the circumstances.
On rare occasions managers may write options as part of a tax management strategy. But other than currency hedging, derivatives are highly unlikely to be part of the funds’ holdings.