The broad sell-off in September confirmed that Wall Street is still in a bear market. However, it also served as a chance for investment firms to prove their alternative strategies are worth a look from investors seeking less volatility. One firm with several winners this year is First Trust, which has multiple funds that have risen in 2022 despite not being pure inverse index funds or energy-focused products, which make up the bulk of top performers’ lists. Ryan Issakainen, an exchange-traded fund strategist at the firm, described the different offerings as a “toolset” for advisors and investors looking to diversify their portfolios, and that markets like this serve as an example of the utility of alternative strategies. “Even as the equity markets start to outperform again, and they will, it’s bad environments like this that remind people why they want to add different risk premiums and assets to their portfolio,” Issakainen said. The funds offer a differentiated return for investors, and they can show the biggest outperformance during broad sell-offs that hit every sector — like September’s decline. Merger Arbitrage A merger arbitration strategy has been a winner for First Trust and a few other investment firms this year. It’s a strategy used by hedge funds — and on occasion even by Warren Buffett — to collect the small upside that often exists between a stock that is being acquired and its announced deal price. First Trust’s Merger Arbitrage ETF (MARB) is actively managed, which means that its portfolio will be different from others in the space. “They want to invest in the deals that have the highest quality and the highest likelihood that they’re actually going to close,” Issakainen said of the managers running the fund. The fund does not have a position in Twitter , for example, which has been in a legal fight regarding its deal with Elon Musk. Merger arbitrage certainly carries risk, but it is mostly different from broader market risks. At the basic level, the strategy works as a bet that a deal will close at the agreed-upon price, creating a small and limited upside for the stock of the company that is being acquired. The risk is that if a deal falls through the stock in question can fall significantly — meaning that these trades often have more potential downside than upside. The First Trust fund also has some short positions on deals that the managers think are likely to not close or close at a lower price. “When the equity market is up 30%, people tend to be less interested in a merger-arb strategy because they tend to be more focused on what we’re doing really well today,” Issakainen said. The fund has attracted more than $70 million of inflows this year, according to FactSet. Another benefit of an actively managed fund during a bear market is that it gives the fund managers the option to do nothing. While the fund is designed to be close to fully invested during normal market conditions, Issakainen said, it currently has a large cash position. However, if the broader market rebounds, the cash pile could become a drag on the portfolio. Another downside of the fund during periods of rising markets is the cost. The fund has a management fee of 1.25%, and First Trust says that interest and margins expenses can push the total cost for investors above 2%. Managed futures Another area where First Trust has had success this year is managed futures products. The firm has two that play in this space — the Alternative Absolute Return Strategy ETF (FAAR) , which uses commodity futures, and Managed Futures Strategy Fund (FMF) , a combo of commodity, equity, currency and interest rate futures. The funds are up roughly 8% and 12% year to date, respectively, and the FMF has pulled in more than $100 million of inflows, according to FactSet. The managed futures strategies give investors a more strategic position than trying to buy broad long funds and inverse funds themselves to take position. They also are tweaked by professional portfolio managers as market conditions change. The funds are a bit more complicated than just buying or shorting the current futures contracts. One part of the strategy is “to identify along the curve which contract in the long portfolio has the highest probability based on a number of different factors of achieving the maximum return,” Issakainen said, describing FAAR. “So once you find out which commodity you want to buy, you need to figure out which contract you want to have a long position on. And they do this on the long and short sides of the portfolio,” he said. While these funds provide investors with more nuanced exposures and professional management, they do come at a cost. The two funds have expense ratios of more than 0.90%, which can be pricey relative to broad index funds that are passively managed.
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