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Seeking Diversification with Upside Potential and Downside Protection
An Alpha Sponsored Report on Liquid Alternatives Investing
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When investment compasses no longer point in any certain directions, asset managers look for new ideas. For some, liquid alts are coming to the rescue. “There is a lot of nervousness today among investors who have enjoyed a good ride with rising equities but are concerned about an equity correction or rising interest rates in the future,” says Michael Bernstein, managing director, head of North America business development, Lyxor Asset Management. “They don’t want to have a portfolio that is only exposed to equities or interest rates.”
Unlike private investments in real estate, equity or hedge funds, liquid alternatives are typically offered in mutual funds or exchange-traded structures that offer daily liquidity, transparency, low leverage and 1099 tax treatment under the provisions of the Investment Company Act of 1940. There are also non-’40 Act liquid alternatives intended primarily for institutions. “Unlike private funds, liquid alternatives are not burdened by cumbersome subscription documents, complicated K-1s, or onerous investor qualification requirements,” says Rick Lake, co-chairman, Lake Partners. “Ease of implementation is a hallmark of liquid alternatives.” According to research firm Morningstar, there are now nearly 430 alternative-strategy mutual funds with a total of $144 billion in assets, up from 116 funds and less than $22 billion 10 years ago. “Liquid alternatives meet a very distinct market need at this point in time,” says Chris Bricker, head of alternatives, AllianceBernstein.
However, both institutional and retail investors need to understand the new wave of liquid alternative funds. “It’s very important to do your analysis, and assess the risks, the exposures and the desired outcomes,” says Christine Johnson, managing director, Alternatives Product Management, AllianceBernstein. “Look at the governance issues as well, since there are new players getting into this market.”
Lake adds that the U.S. Securities and Exchange Commission (SEC) is has embarked on a broad sweep of liquid alts to make sure that the foundation of investor protection remains strong. He says, “The sweep will also enable the SEC to provide updated and comprehensive guidance for the liquid alternatives industry, which utilizes techniques and instruments that may not have existed when applicable legislation and regulations were first drafted.”
However, the growth of liquid alternatives extends beyond the U.S. to include Europe and other global markets. Lake says some managers with global footprints have adapted their alternative offerings for regional preferences and cross-border regulatory differences.
In the U.S., endowments and foundations have been steadily adding liquid alternatives to their portfolios, notes Bernstein, adding that public pensions, which have been on the low end, are also increasing their allocations.
Andrew Arnott, president and CEO, John Hancock Investments, says liquid alternatives are increasingly popular among both institutional and retail investors. “What we haven’t seen yet is the use of liquid alts in the defined contribution plan marketplace, although some 401(k) sponsors are considering them for their more advanced glidepaths,” he says.
A range of strategies
Liquid alternative funds provide investors with access to a wide range of strategies typically associated with hedge funds. Investors can pick and choose among options like absolute return, long-short equity, fixed-income oriented, managed futures, event-driven, currency and global macro strategies, as well as multi-strategy funds that combine several approaches.
狮子座Zerilli,投资主管约翰·汉考克发票estments, says absolute return strategies appeal to many fixed-income investors. He notes that the returns on Barclays Capital Aggregate Bond Index over time are comparable to an absolute return fund with a cash plus 3 percent target.
Long-short equity strategies are also high on the list for many investors. adds Zerilli. “There are three ways a long-short manager can add alpha to a portfolio,” he says. “They can pick good stocks for the long side, short stocks, and manage the portfolio exposure in positive trending and distressed markets.”对多数的需求也是强大的strained, non-traditional and long-short bond funds, according to Lake. “Concerns over rising rates and duration risk are driving investors to hedge their fixed income exposure,” he says. “With interest rates at historic lows, investors are also searching for additional sources of yield.”
While many liquid alternative strategies are designed to generate potentially higher returns (alpha), others are aimed at reducing market risk (beta), or providing exposure to market trends like momentum or volatility. For example, liquid alternative funds using event-driven strategies may provide investors with downside protection in case of a decline in the equity markets.
“New products are being developed that offer simple, low-cost, liquid strategies designed to provide just the alternative beta component,” says Bernstein. “An investor who is trying to diversify the portfolio in smart ways might look at these new offerings.”
By bringing a variety of strategies together in one package, multi-strategy funds can simplify
the research and due diligence process. “Multi-alternative funds can serve as a core alternatives allocation or as a one-stop solution for professionals and investors,” says Lake.
Both single- and multi-strategy funds can also help investors build a portfolio of alternatives across the liquidity spectrum – a recent trend among institutional investors and family offices, says Lake. Such portfolios may include daily-valued liquid alternatives; hedge funds with weekly, monthly, or quarterly liquidity; and illiquid investments such as private
equity or direct real estate. Lake says, “Liquid alts can be used to meet capital calls or cash
requirements, managing liquidity at the margins of the portfolio.”
Best practices
With a wide range of choices in liquid alternatives, investors should search carefully for fund strategies that complement their investment goals and managers with the appropriate skill sets. The challenges include the greater complexity of liquid alt strategies, and a shorter track record of performance for many recent offerings.
Bricker emphasizes the importance of the fund’s manager, since there is a greater dispersion of high and low returns in liquid alternatives compared with traditional asset classes with benchmarks like the S&P 500. The complexity of liquid alt strategies combined with lack of
benchmarks, in most cases, raises the potential for significantly better or worse returns.
Noting that cost is always a factor in choosing products, Bernstein says fund performance
should be the key consideration. “While some products have a management fee without a performance fee component, that can be a double-edged sword,” he says. “We believe that a performance fee tends to align the interests of the manager with the investor and attract higher-quality managers and strategies.”
Finally, Arnott also emphasizes the importance of understanding the resources available to the fund manager. “You need a strong team that can generate ideas, construct the portfolio and manage the risks of those positions,” he says. “You also want a manager who puts the client’s interest first.”