Expectations
Given that liquid alternative funds are designed to smooth volatility and deliver decent returns in the process, have they fulfilled their mission during the past five years? An easy question, but it’s not so easy to answer.

Jim Holtzman, a financial planner with Legend Financial Advisors Inc. in Pittsburgh, says his firm has switched its clients’ alternative investment exposure from private limited partnerships to open-end mutual funds for liquidity and transparency reasons. “From a risk mitigation standpoint, we believe they’re serving their purpose,” he notes. “But regarding returns, we would’ve expected more in this environment. It’s been a real challenge.”

Dan Moisand, a financial planner and principal at Moisand Fitzgerald Tamayo LLC in Melbourne, Fla., sees the growth in liquid alternative funds as another example of investors chasing a hot trend.

“Liquid products are created because they can be sold,” he says. “That’s classic Wall Street. Whatever is hot they’ll create products to put people into. The point I make all the time is there’s not one client who risks failing to reach their goals because they don’t own any alternatives.”

Nonetheless, advisors haven’t given up on liquid alternative funds. Nadia Papagiannis, director of alternative investment strategy for global third-party distribution at Goldman Sachs Asset Management, says she’s seen a change in emphasis in how advisors approach alternatives.

“Most advisors we’ve talked to are less concerned about an equity market drawdown than they are about rising interest rates,” she notes, adding that alternative investments have historically done well in rising interest rate environments.

Papagiannis says she has measured six rising rate environments since 1990 (the inception date of the HFRI Fund of Funds Composite Index, which can be used as a proxy for alternative funds), and in those environments alternatives had positive returns all six times and the returns were substantially better than the Barclays U.S. Aggregate bond index.

“If you’re heavy into bond exposure and you want to diversify, alternatives are a potentially good way to do that,” Papagiannis says.

Ryan Tagal at Envestnet says he’s seeing growing interest in liquid alternative funds from advisors on his company’s investment platform, particularly in non-traditional fixed-income funds with mandates to be more tactical in credit and duration.

Tagal says Envestnet’s platform contains roughly 600 liquid alternative funds (including various share classes). “Envestnet has a broad platform, and we want to give advisors access to a lot of products,” he says. But of those 600 funds, only about 140 are approved (meaning the Envestnet research team has looked at them and compared them with their peers), and of these, only 15 are considered to be top picks.

“These have been vetted regarding fees, hedging strategies and proper risk controls,” he says. Among those top picks are the BlackRock Emerging Markets Long/Short Equity fund (BLSIX), the Robeco Boston Partners Long/Short Research fund (BPIRX) and the AQR Managed Futures Strategy I fund (AQMIX).

Tagal says Envestnet recommends an allocation of up to 25% in alternative mutual funds in some of its models. He adds that Envestnet educates interested advisors about how to deploy alternatives in client portfolios.

“We’re spending a lot of time digging into it because there are more products out there, and we want to be able to provide context to advisors to help them make the choice of whether they ultimately want to use them and how they fit into a portfolio,” Tagal says.
 

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