Liquid alternative investments, commonly referred to as liquid alts, are mutual funds or exchange-traded funds (ETFs) designed to provide investors with diversification and downside protection. Unique for their daily liquidity, these investments make alternative strategies accessible to everyday investors without the need for high net-worth or income qualifications.
Key Benefits and Criticisms
Benefits:
- Liquid alts offer daily liquidity, making them easier to buy and sell compared to traditional alternative investments that have monthly or quarterly liquidity.
- They come with lower minimum investment requirements, removing barriers that typically prevent smaller investors from accessing hedge fund strategies.
Criticisms:
- Skeptics argue that the promised liquidity may not hold up during severe market downturns, as most of the capital entered the market during a bull phase post-financial crisis.
- Critics also highlight the high fees associated with liquid alts, which can be a disadvantage to retail investors.
For enthusiasts, liquid alts are seen as a significant innovation because they democratize investment strategies historically reserved for the financial elite.
Comprehensive Understanding of Liquid Alts
Liquid alts aim to overcome the limitations of alternative investments by offering funds that are redeemable on a daily basis, much like traditional mutual funds.
What are Alternative Investments?
Alternative investments encompass nearly any asset type that isn’t a straightforward stock or bond. Some examples include fine art, private equity, derivatives, commodities, real estate, distressed debt, and others. A notable drawback of these investments is their lack of liquidity. Selling such assets usually requires more time and effort compared to high-liquidity assets like stocks.
Criticism of Liquid Alternatives
The popularity of liquid alternative funds surged following the 2007 financial crisis. Individual investors and advisors have sought to buffer against downside risk by leveraging hedge fund-like strategies.
Statistics:
- A survey revealed that 63% of advisors planned to allocate over 11% of their portfolios to liquid alts within five years (as of July 2015).
- Despite these intentions, the period has seen numerous fund closures and consolidations. Market size reached $192 billion by the end of 2015 but has seen inconsistent growth since.
- Asset size rebounded to $184 billion by the end of the third quarter in 2017 from $179 billion in 2015.
Examples of Liquid Alt Strategies and Sub-Categories
There are numerous strategies within the space of liquid alternatives, predominantly falling into the categories identified by Morningstar:
Major Categories:
- Long-Short Equity: Funds focusing on equity securities and derivatives, combining long and short positions based on the fund’s macro outlook.
- Nontraditional Bond: These funds adopt unconventional approaches to bond investing, aiming for returns uncorrelated with the standard bond market.
- Market Neutral: Designed to minimize systematic risks, these funds balance long and short positions to achieve low beta.
- Managed Futures: Investing mainly via derivatives like futures, options, and swaps, these funds use momentum or mean-reversion strategies.
- Multialternative: These combine various alternative strategies, either maintaining fixed allocations or adapting based on market conditions.
Specialized Categories:
- Bear-market
- Multi-currency
- Volatility
- Trading-leveraged commodities
Institutions like Citi and Goldman Sachs additionally identify various structures and strategies within liquid alternative funds, ranging from multi-alternatives to event-driven and relative value funds.
Unlock the potential of liquid alternatives to diversify your portfolio and protect against downside risk, making sophisticated investment strategies more accessible to all investors.
Related Terms: alternative investments, mutual funds, ETFs, hedge funds.
References
- Morningstar. “Potholes and Opportunities in Alternative Investments”.
