Key Takeaways
- • Morningstar introduced a Style Box framework for alternative funds, becoming available to Morningstar Direct clients at the end of October 2017, enabling systematic evaluation of liquid alternatives investments across a nine-region grid.
- • The alternatives style box uses correlation and volatility relative to global equities as its two primary components, allowing investors to quickly assess diversification potential and compare funds across different Morningstar Categories.
- • Significant diversity exists among alternative strategies even within the same Morningstar Category, demonstrating that funds pursuing similar strategies can exhibit materially different diversification characteristics and risk profiles.
- • The framework helps investors set realistic performance expectations and make informed portfolio-allocation decisions, potentially reducing performance-chasing behavior that typically undermines long-term investment outcomes.
- • Cross-category fund comparisons become more intuitive through the style box, enabling investors to identify funds with similar diversification attributes regardless of categorical classification.
Summary
Morningstar has developed a new analytical framework designed to bring greater clarity and consistency to the evaluation of liquid alternative investments. The Morningstar Style Box for alternative funds, rolling out to Morningstar Direct subscribers by the end of October 2017, represents an extension of the firm's established style box methodology—previously applied to equity and fixed-income funds—adapted specifically for the alternatives universe.
The framework organizes alternative funds into nine distinct regions based on two core variables: correlation to global equities and relative volatility. This two-dimensional approach provides institutional investors with a visual, intuitive tool for assessing how alternative strategies are likely to behave within broader portfolio contexts. By mapping funds according to these dimensions, the style box enables investors to quickly gauge diversification potential—a critical consideration for alternative allocations where the primary investment thesis often centers on portfolio diversification benefits rather than absolute returns.
A foundational finding from Morningstar's analysis is the substantial heterogeneity within traditional alternative fund categories. Funds classified within the same Morningstar Category frequently exhibit markedly different correlation and volatility profiles, meaning that categorical designations alone provide insufficient guidance for investors conducting detailed strategy evaluation. This diversity underscores the analytical value of tools that cut across categorical boundaries and focus on underlying risk and correlation characteristics.
The style box addresses a specific investor behavior challenge: the tendency to chase performance, which historically undermines long-term returns. By enabling investors to establish clear, quantitative expectations for a strategy's diversification attributes and expected volatility relative to equities, the framework promotes more disciplined portfolio construction and allocation decisions. This expectation-setting function may prove particularly valuable during market dislocations, when alternative strategies are most likely to be tested and when performance-chasing decisions are most costly.
The rollout of this framework to Morningstar Direct—the firm's institutional-grade research platform—signals the maturation of systematic analytical approaches to alternative fund evaluation and reflects growing institutional demand for transparent, comparable metrics across the increasingly complex landscape of liquid alternatives.
The framework organizes alternative funds into nine distinct regions based on two core variables: correlation to global equities and relative volatility. This two-dimensional approach provides institutional investors with a visual, intuitive tool for assessing how alternative strategies are likely to behave within broader portfolio contexts. By mapping funds according to these dimensions, the style box enables investors to quickly gauge diversification potential—a critical consideration for alternative allocations where the primary investment thesis often centers on portfolio diversification benefits rather than absolute returns.
A foundational finding from Morningstar's analysis is the substantial heterogeneity within traditional alternative fund categories. Funds classified within the same Morningstar Category frequently exhibit markedly different correlation and volatility profiles, meaning that categorical designations alone provide insufficient guidance for investors conducting detailed strategy evaluation. This diversity underscores the analytical value of tools that cut across categorical boundaries and focus on underlying risk and correlation characteristics.
The style box addresses a specific investor behavior challenge: the tendency to chase performance, which historically undermines long-term returns. By enabling investors to establish clear, quantitative expectations for a strategy's diversification attributes and expected volatility relative to equities, the framework promotes more disciplined portfolio construction and allocation decisions. This expectation-setting function may prove particularly valuable during market dislocations, when alternative strategies are most likely to be tested and when performance-chasing decisions are most costly.
The rollout of this framework to Morningstar Direct—the firm's institutional-grade research platform—signals the maturation of systematic analytical approaches to alternative fund evaluation and reflects growing institutional demand for transparent, comparable metrics across the increasingly complex landscape of liquid alternatives.
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