Investors have taken a shine to the plethora of ’40 Act funds offering alternative investment strategies that have launched since the financial crash five years ago.

But some people have questioned whether these funds pack the same performance potential as alternative investments found in private partnership structures, such as hedge funds, that don’t have restrictions placed on them by the Investment Company Act of 1940 regarding leverage, liquidity and diversification.

A recent study from Cliffwater LLC examined whether the so-called liquidity discount was truth or fiction. The result? On average, returns on liquid alternatives trail private alternatives by about 1 percent.

Alternative investment strategies aim to reduce portfolio volatility by providing low correlation to traditional stocks and bonds. Traditionally, they were the domain of institutions and accredited investors who accessed them through private partnerships with long lock-up periods, restricted redemption periods and hefty fees.

But the influx of alternative strategies available in more liquid––and less costly––investment vehicles has made it easier for retail investors to play the game.

Cliffwater, an alternative investments advisory services firm in Marina del Rey, Calif., based its study on monthly net-of-fee return data from 109 investment firms that manage both private and liquid offerings under the same general alternative strategy. The firm said it focused on the larger and more well-known firms among the roughly 400 investment firms it believes could’ve qualified for its study.

Those 109 participating firms provided a total of 148 private/liquid pairings that included five different liquid structures offering daily and/or weekly liquidity:

• Open-end ’40 Act mutual funds

• Separately managed accounts

• Undertakings for Collective Investment in Transferable Securities (UCITS), a European regulatory structure somewhat similar to U.S. ‘40 Act funds

• Platforms offered by large bank, broker/dealer or wealth management firms

• Listed securities, which includes closed-end funds.

Cliffwater found that for the 10-year period ending March 2013, the average annualized difference in return between private and liquid alternative products was 0.98 percent. Or, as Cliffwater described it in its study, “The average investor is paying, in reduced return, approximately 1% per year for the preferential liquidity found in retail oriented alternative products versus their institutional private partnership counterparts.”

In its study, Cliffwater said it can’t comment on whether the average 1 percent difference is a fair price to pay for greater liquidity, but noted that it’s consistent with other public/private liquidity comparisons such as yield differences between private and public debt.

According to the study, event-driven and market-neutral strategies had the largest differences––or the highest cost of liquidity––at 2.26 percent and 2.24 percent, respectively.

Macro and managed futures strategies had the lowest differentials at 0.22 percent and 0.48 percent, respectively.

Among the other strategies analyzed in the study, the average cost of liquidity was 1.07 percent for long/short equity; 0.95 percent for credit and 0.61 percent for multi-strategy.

Cliffwater’s study didn’t include commodity, currency and short-biased strategies because they didn’t have significant enough private/liquid pairings.