Meanwhile, firms that have had previous success in hedge fund management, such as Millburn Corp. or Informed Portfolio Management (IPM), are increasingly partnering with traditional retail fund management firms to launch liquid alt mutual funds. “The big hedge funds have learned that it’s hard to make the transition to mutual funds on their own,” says Andrew Rogers, CEO of Gemini Funds Services, a full-service fund administrator providing compliance, distribution and risk reporting services.
High Fees? Low Fees? Yes
The other industry challenge involves fee structures, which tend to be much lower than those of hedge funds but higher than those of traditional mutual funds. And in light of the market share that stock and bond ETFs have taken from their mutual fund counterparts, it’s fair to ask if a similar trend will play out among liquid alts.
Indeed, a number of the bigger firms such as Goldman Sachs and Blackstone are moving to cover both bases. “Certain alt approaches will lend themselves to passive management, while others will still require an active hand,” says Restieri. Goldman has been rolling out new liquid alt mutual funds and ETFs simultaneously.
Altegris’s Osborne concurs, noting that “there is a continuing move towards lower fee solutions.” He is seeing an emergence of quantitative strategies that focus on factors such as carry trades or value-versus-growth algorithms. Those funds can utilize smaller portfolio management teams and can pass on the savings as a result.
Baby Boomers To The Rescue
Perhaps the single greatest factor in favor of liquid alts is demographics. Roughly 10,000 baby boomers turn 65 every day, and that trend will stay intact for the next 14 years.
These investors are a natural fit for liquid alts’ capital preservation approach. For any investors that hoped to retire near the end of the last decade, the sharp market drops in 2008 and 2009 led to a painful readjustment in the timing of retirement. Soon-to-be retirees today are surely cognizant of that period.
In a recent white paper entitled “Liquid Alternatives: The Next Wave in Asset Allocation,” the alternative asset management team at Lazard Asset Management noted that liquid alternative strategies offer “a potential buffer to equity market downturns.” They think baby boomers will need “assets with characteristics such as lower volatility return streams, some measure of capital preservation during negative market environments, and diversification.” The key takeaway: “Liquid alternative funds will be a solution that is increasingly part of the asset allocation decisions for millions of Americans.”
Cream Rising To The Top
With so many new funds hitting the market in recent years, performance is starting to become the primary selling point, especially in lagging sub-categories. In the long/short category, the average fund had lost an average of 4.5% in the one-year period through April 27, 2016. Yet some managers like Harin de Silva, president of Analytic Investors, have started to build a strong following.
De Silva’s firm sub-advises the 361 Global Long/Short Equity Fund (AGAQX), which delivered a 9.9% return over the past year. The approach is quite transparent. For every $100 invested on the long side in low-beta and low-volatility stocks, another $30 is used to short high-beta stocks.
De Silva thinks that long-only strategies can only benefit from a rising market. “But in a long/short strategy, you need a much defter hand,” he says. The recent market backdrop has been favorable for him and his team. “The choppier the market, the better for us.”
But the dispersion of returns among long-short funds has been all over the place. Successful short-sellers “combine macro insight, thematic analysis, and fundamental stock selection with specialized risk-management techniques,” says Rick Lake, co-chairman of Lake Partners
Profitable shorts in recent market downdrafts capitalized on evolving market dynamics, according to Lake. “Last summer, investors grew increasingly discriminating in stock selection. This created multiple short opportunities—weak companies that were no longer being lifted by a rising market, former ‘hype’ and ‘hope’ stocks that were unable to meet unrealistic expectations, and companies that were leveraged to a downturn in energy and commodities.”
Investors can also choose from a variety of other funds that have generally delivered category-beating returns and high marks from Morningstar. The AQR Managed Futures Strategy Fund (AQMIX), which gets a five-star rating from Morningstar, has scored in the top 10% of all managed futures funds on a three- and five-year basis. The 1.23% expense ratio is also below the industry average. The fund takes a complex but thus far successful approach to price movements in various asset classes. Its managers invest in futures contracts covering four asset classes (stocks, bonds, commodities and currencies) and alters various weightings in response to short-term and long-term technical trends.
John Hancock’s institutional arm has posted impressive results working with a number of sub-advisors. In 2014, the Boston Partners Long/Short Equity fund was named Morningstar manager of the year in the alternatives category, and in 2015, the John Hancock Global Absolute Return Strategies fund and Boston Partners Long/Short research fund were both runners-up.
The BlackRock Multi-Asset Income Portfolio Investor C Shares (BCICX) fund has been a top performer in the multi-asset category. The fund, which invests in stocks, bonds and a range of alternative investments, has a dual focus on capital preservation and income generation. The fund, which merits a “Bronze” rating from Morningstar, benefits from the broad set of research resources that BlackRock Investments can offer to the fund management team.
Perhaps the greatest measures of performance and value for liquid alt funds can be found in their Sharpe ratios (for risk-adjusted returns) and fund expenses. By those measures, the Vanguard Market Neutral Fund Institutional Shares (VMNIX) fares quite well. The fund’s 0.95 Sharpe ratio is tops in its category, according to Morningstar, while the 0.15% expense ratio (it’s 0.25% for retail investors) is almost unheard of in the liquid alt space.
A Transitional Year
In many respects, 2016 is shaping up to be a transitional year for the liquid alts industry. The frenzied pace of asset inflows after the Great Recession of 2008 and 2009 has come to an end, replaced by a rotation away from some approaches that have lost popularity (such as non-traditional bond funds) and toward approaches that are seen as more relevant for today’s markets (such as managed futures funds).
The industry is also welcoming the increased attention of traditional asset management firms such as Blackstone and Goldman Sachs, along with retail investing giant Vanguard. And thanks to enhanced educational efforts industrywide, investors are slowly moving up the learning curve with these funds. Despite some recent industry growing pains, the asset category, and the funds that back them, should garner greater acceptance in the years ahead.