Key Takeaways
- • Morningstar launched a Style Box framework for alternative funds, becoming available to Morningstar Direct clients at the end of October 2017, designed to evaluate liquid alternatives investments using correlation and volatility metrics relative to global equities.
- • The alternatives style box organizes funds into nine regions based on two key dimensions—correlation and relative volatility—enabling investors to quickly assess diversification potential and compare funds across different Morningstar Categories with greater precision.
- • Significant diversity exists within the alternative strategies universe; funds in identical Morningstar Categories pursuing similar strategies frequently exhibit markedly different diversification characteristics, highlighting the critical need for comparative evaluation tools.
- • The framework helps investors set realistic performance expectations and make informed portfolio-allocation decisions by analyzing both correlation and volatility attributes, potentially reducing performance-chasing behavior that typically undermines investor outcomes.
Summary
Morningstar introduced a Style Box framework specifically designed for alternative funds, positioning it as a research tool for evaluating liquid alternatives investments. The framework became available to Morningstar Direct clients at the end of October 2017, building on foundational concepts introduced in an October 2016 research paper. The tool addresses a longstanding gap in alternative investment analysis by providing a structured methodology for comparing funds across disparate categories.
The alternatives style box operates on two core dimensions: correlation to global equities and relative volatility. These metrics are displayed across a nine-region grid, offering investors an intuitive visual representation of where any given liquid alternative fund positions itself within the broader alternative strategies universe. By mapping funds according to these characteristics, the framework enables side-by-side comparisons that would otherwise be difficult to conduct, particularly when evaluating funds from different Morningstar Categories.
The research underlying the framework reveals substantial heterogeneity among alternative strategies. A bottom-up examination of the alternatives universe found that funds within the same Morningstar Category—those pursuing ostensibly similar strategies—often demonstrate meaningfully different diversification attributes. This finding underscores a critical insight for institutional investors: category classification alone is insufficient for thorough fund evaluation. The style box addresses this limitation by providing an additional layer of analytical rigor.
For portfolio construction purposes, the framework serves a dual function. First, it enables more precise fund selection by allowing investors to identify strategies with comparable diversification characteristics across different category boundaries. Second, it supports realistic expectation-setting regarding a fund's behavior and contribution to overall portfolio risk-return dynamics. By explicitly considering both correlation and volatility dimensions, investors are better positioned to make allocation decisions grounded in quantifiable diversification metrics rather than category labels or recent performance trends. This approach has potential implications for reducing performance-chasing behavior, which historically has undermined institutional investor outcomes in alternative strategies.
The alternatives style box operates on two core dimensions: correlation to global equities and relative volatility. These metrics are displayed across a nine-region grid, offering investors an intuitive visual representation of where any given liquid alternative fund positions itself within the broader alternative strategies universe. By mapping funds according to these characteristics, the framework enables side-by-side comparisons that would otherwise be difficult to conduct, particularly when evaluating funds from different Morningstar Categories.
The research underlying the framework reveals substantial heterogeneity among alternative strategies. A bottom-up examination of the alternatives universe found that funds within the same Morningstar Category—those pursuing ostensibly similar strategies—often demonstrate meaningfully different diversification attributes. This finding underscores a critical insight for institutional investors: category classification alone is insufficient for thorough fund evaluation. The style box addresses this limitation by providing an additional layer of analytical rigor.
For portfolio construction purposes, the framework serves a dual function. First, it enables more precise fund selection by allowing investors to identify strategies with comparable diversification characteristics across different category boundaries. Second, it supports realistic expectation-setting regarding a fund's behavior and contribution to overall portfolio risk-return dynamics. By explicitly considering both correlation and volatility dimensions, investors are better positioned to make allocation decisions grounded in quantifiable diversification metrics rather than category labels or recent performance trends. This approach has potential implications for reducing performance-chasing behavior, which historically has undermined institutional investor outcomes in alternative strategies.
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