Rick Lake, co-founder and co-chair of Lake Partners, a Stamford, Conn.-based consulting firm with 25 years’ experience in alternative investments and a 15-year track record in liquid alts, says he is pleased to see the widening availability of alternative strategies in liquid formats and an accelerating migration of highly experienced alternative managers from the institutional and private world.

“We may be entering a golden age of liquid alternatives,” says Lake, whose firm had approximately $4.7 billion of consulting assets and $656 million of assets under management as of September 30. “But distinguishing experienced managers from newcomers is key,” he says.

To sort through the plethora of options, advisors and investors will need to devote more time and resources to liquid alts research or align themselves with firms that have a dedicated liquid alt research team, he says. “Advisors will need to climb the learning curve or find the research support,” he adds.

This past summer, Lake’s Aston/Lake Partners LASSO Alternatives Fund (ALSOX/ALSNX) reduced its allocation to long-short equity because of concerns about potential volatility, and redeployed some assets to long-short fixed income and global macro strategies. Global macro aims to capitalize on changing dynamics in equity, fixed-income, currency and commodities markets.

The LASSO (Long and Short Strategic Opportunities) fund of funds now allocates about half its assets to long-short equity (U.S. and global), 30% to long-short fixed income, 10% to arbitrage and event-driven strategies and 10% to global macro.

Lake says he likes to see a “robust translation” when an alternative strategy is carried over from a private hedge fund to a liquid regulated structure. “Sometimes the original strategy is diluted so it’s an issue of concern,” he says.

Translation is also very important to John Shearman, CEO of IV Lions LLC, a San Francisco Bay Area RIA firm, and previously a partner at a global alternative investment advisory firm. “If a strategy is pulled from the hedge fund world and pushed through the ’40 Act, what comes out on the other side?” he says.

Factors that can be lost, he says, include leverage, the illiquidity premium and manager talent. Another key consideration with liquid alts, he says, is risk shuffle—swapping out standard deviation risk in exchange for an increase in risk of a large, unexpected loss.

He does like that liquid alts can help advisors expose clients to diversifying sources of return without the risks that can accompany hedge fund investing, such as illiquidity, complex tax structures and leverage-related financing woes.

Shearman, who recently co-authored the book Liquid Alts: A Guide For Financial Advisors and Advanced Investors, was surprised to see so many liquid alts being used in the retail market. “There’s really a revolution going on,” he says. Portfolios he inherits often have long-short credit and arbitrage strategies in place.

Staying Well-Hydrated
Meyer Capital Group, a fee-only investment management and financial planning firm in Marlton, N.J., began using liquid alts around 2007 and currently allocates nearly 20% of its approximately $750 million of assets under management to them. All of its roughly 650 clients have exposure to them. “It’s a great way to bring these types of strategies to the mass affluent,” says CEO Thomas Meyer, referring to people with $500,000 to $1 million in investable assets.

Still, “It’s not a silver bullet,” he tells clients. “It’s a shock absorber for your portfolio.” He teaches them the fundamentals of liquid alts but avoids being too technical.

Meyer says the flood of new products is getting out of hand. “Every Tom, Dick and Harry firm is basically trying to get into liquid alternatives right now, which makes our jobs as RIAs more difficult,” he says. Not only does it require more due diligence, he says, “Probably 70% of this stuff hasn’t even been battle-tested.”

Meyer asks managers how they manage risk and about consistency of risk-adjusted returns. He also asks them why the strategy should add value over time, in what market environment the product would have difficulty outperforming and what enhancements they have made to their investment process in the last five years.

The funds he uses that employ alternative strategies include Schooner I (SCNIX), Gotham Absolute Return (GARIX), two Robeco Boston Partners long-short products (BPRRX and BPLEX), Iron Strategic Income (IFUNX), JP Morgan Strategic Income Opportunities (JSOSX) and John Hancock Strategic Income Opportunities (JIPIX).

The income funds provide exposure to high-yield bonds and derivatives. “We’d never do this stuff on our own,” says Meyer. “We haven’t bought a bond in two years.”