What Are Liquid Alternatives?
Let me explain what liquid alternative investments, or liquid alts, really are. These are mutual funds or exchange-traded funds (ETFs) designed to give you diversification and some protection against market drops by exposing you to alternative investment strategies. The big draw here is their liquidity—you can buy and sell them daily, unlike traditional alternatives that might only let you in or out monthly or quarterly. Plus, they have lower minimum investments than typical hedge funds, and you don't need to meet any net-worth or income thresholds to get started.
Now, critics will tell you that this liquidity might not hold up when markets get rough. A lot of money flowed into liquid alts during the bull market after the financial crisis, but skeptics argue the fees are too high. On the flip side, supporters see them as a smart way to democratize hedge fund strategies for everyday investors like you.
Key Takeaways
To sum it up directly, liquid alts are alternative investment options aimed at making things easier for retail investors. They use many of the same strategies as hedge funds but offer much better liquidity, allowing you to buy and sell shares whenever you want. They also come with lower minimum investments. That said, critics point out they're not a perfect solution—they carry unique risks that aren't always clear, high fees, and they might shut down or struggle during volatile times.
Understanding Liquid Alts
Liquid alts are built to fix the main problems with traditional alternative investments by letting you access them through products you can redeem daily, just like a regular mutual fund. Think of alternative investments as anything outside plain stocks or bonds—things like fine art, private equity, derivatives, commodities, real estate, distressed debt, or hedge funds. The issue with these is their lack of liquidity. You can sell a $5,000 stake in a stock like Alphabet in seconds without moving the price, but offloading an alternative investment takes way more time and effort, often with lock-up periods, and it's hard to invest small amounts.
Criticism of Liquid Alternatives
Since the 2007 financial crisis, the number of liquid alt funds has exploded as investors and advisors like you seek ways to guard against downside risk using hedge fund tactics. A 2015 survey by Barron's and Morningstar showed 63% of advisors planning to put more than 11% of portfolios into liquid alts in the coming years. But since then, we've seen a wave of fund closures and consolidations, slowing growth. By the end of 2015, the market hit $192 billion in assets, dipped, and rebounded to $184 billion by Q3 2017.
Critics are straightforward: these funds charge higher fees than other actively managed mutual funds. Also, packing illiquid assets into something liquid could backfire. Hedge funds often limit withdrawals to quarterly or yearly, but with liquid alts, easy trading is a selling point. If a market downturn causes a rush to sell, funds might have to dump assets at a loss, and you'd feel the pain as an investor.
Examples of Liquid Alt Strategies and Sub-Categories
Morningstar breaks liquid alt strategies into 12 categories, with the biggest ones making up over 80% of the funds. Take long-short equity: these funds focus on stocks and derivatives, mixing long positions with shorts via ETFs, options, or direct shorts, adjusting based on the broader market view. Nontraditional bond funds stray from standard bond investing to get returns not tied to the bond market, like unconstrained funds diving into high-yield foreign debt. Market neutral funds aim to cut systematic risks by balancing shorts and longs in sectors, countries, or currencies for low beta exposure. Managed futures use derivatives like futures, options, swaps, and forex, often following momentum or mean-reversion strategies. Multialternative funds blend various strategies, either fixed or shifting with market changes.
Other Categories and Classifications
- Other categories include bear-market, multi-currency, volatility, and trading-leveraged commodities.
- Citi classifies liquid alts into single-manager funds, multi-alternatives, and commodities or managed futures funds.
- Goldman Sachs categorizes them to mirror hedge fund strategies: equity long/short, tactical trading/macro, multistrategy, event-driven, and relative value approaches.
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