What are liquid alternatives?
Liquid alternatives refer to daily liquid open-end funds, such as mutual funds and ETFs, which invest across a broad range of alternative investment strategies. Collectively, these types of funds are often referred to as “liquid alts.” Liquid alternative funds manage approximately $367 billion¹ in assets across a diverse range of strategies.
U.S. liquid alternative funds assets under management¹
Why invest in liquid alts?
While the universe is broad and diverse, most liquid alts aim to help diversify a traditional stock and bond portfolio and minimize volatility by:
- Generating returns that have low correlation to traditional assets
- Potentially limiting the impact of large market downturns
What are alternative investment strategies?
Traditional “buy and hold” – or long-only – mutual fund strategies invest with the expectation to own securities over the long term, regardless of market fluctuations. Alternative strategies, on the other hand, typically take both long and short positions across stocks, bonds and currencies, among other asset classes.
In long/short investing, managers buy securities they expect to appreciate in value and sell short securities they expect to decline in value in order to generate returns regardless of market direction. In addition, they may also use options, futures contracts and other derivatives more extensively than traditional strategies to achieve their investment objectives.
Differences in how most traditional and alternative – or institutional-style – strategies invest matter because they usually target different outcomes.
The goal of most traditional strategies is to outperform a benchmark. However, over time their performance is typically tied to the performance of the broader markets – both in rising and declining markets.
Alternative strategies seek to generate a targeted level of return with lower volatility than a traditional portfolio over time – regardless of how markets perform. For this reason, many alternative strategies are often referred to as absolute return strategies.
What are some examples of alternative strategies?
As noted above, long/short equity investing is one of the most popular alternative strategies and is designed to reduce an investor’s exposure to the broader swings in the market. Other popular strategies are listed below. In addition, many liquid alternative funds in the market today take a multi-strategy approach that combines several strategies in a single fund to achieve their objectives.
Seeks to capitalize on price inefficiencies due to corporate events or the maturity/call date of a corporate debt security
Seeks to buy stocks expected to increase in value and short stocks expected to decline in value to hedge out market exposure
Seeks to invest in assets whose value is determined to be more attractive than that of similar assets
Seeks to profit from shifting economic expectations or political events by placing directional bets on security or currency prices through futures instruments
Accessing alternative strategies through liquid alts
Many large institutions, such as pension funds and endowments, have invested in alternative strategies for decades through hedge funds. High investment minimums and other restrictions, however, put hedge funds out of reach for most individuals.
With the growth of liquid alts over the last decade, these strategies have become more accessible for individuals. Some key features of liquid alts include:
- Daily liquidity
- Transparency into fund holdings and performance
- Low investment minimums
- Regulatory oversight
When considering the use of liquid alternatives, investors should have clear expectations of its purpose. Certain strategies may be better portfolio diversifiers, while others may provide return enhancement potential. Diversification does not eliminate the risk of experiencing investment losses. Investing in liquid alternatives may involve the use of options or other derivatives which may incur additional risk, including the risk of a complete loss of investment. When building a portfolio that includes liquid alternative investments, financial professionals and their investors should first consider the individual’s financial objectives. Past performance is no guarantee of future results.
Understanding why and how institutions allocate to alternative strategies can provide individuals insight into how to incorporate them into their own portfolios.