Liquid alternatives

Learn how liquid alternative funds may help individuals diversify their traditional stock and bond portfolios.

Liquid alternatives

Learn how liquid alternative funds may help individuals diversify their traditional stock and bond portfolios.

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 $255 billion1 in assets across a diverse range of strategies.

U.S. liquid alternative funds assets under management¹

Bar chart of U.S. liquid alternative funds assets under management over time.

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.

Icon of a calendar.

Event driven
Seeks to capitalize on price inefficiencies due to corporate events or the maturity/call date of a corporate debt security

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Equity hedge
Seeks to buy stocks expected to increase in value and short stocks expected to decline in value to hedge out market exposure

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Relative value
Seeks to invest in assets whose value is determined to be more attractive than that of similar assets

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Global macro
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

Investor considerations

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.

  • Morningstar Research, as of December 31, 2022.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.


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