Struggles Persist for Liquid Alternatives Despite Decade of Challenges, Remaining a Potential Option
In the ever-evolving world of investments, the spotlight is shifting towards liquid alternatives. As Francesco Paganelli, Senior Manager and Research Analyst at Morningstar, suggests, the time may be ripe for these innovative investment vehicles to demonstrate their worth.
The rise of liquid alternatives can be traced back to the 2008 financial crisis, when investors sought protection from stock market tumbles while still maintaining the daily liquidity of mutual funds. However, the sector has faced its fair share of challenges, with high-profile scandals such as H20, Woodford, and GAM tarnishing its image.
Despite several years of being out of favor, the market environment is changing. The uncertainty surrounding the future path of traditional 60/40 portfolios, coupled with the low yields on bonds, is making investors reconsider their alternatives allocation. Many managers and asset allocators are starting to view traditional assets such as stocks and bonds as expensive.
So, what makes liquid alternatives well-positioned for these changing market conditions?
Firstly, their liquidity. Liquid alternatives, particularly in ETF or mutual fund form, allow investors to trade swiftly and at reasonable costs, even in volatile markets. ETFs, in particular, benefit from dual liquidity sources—the secondary market where the ETF trades and the primary market of underlying securities—helping maintain trading efficiency during stress.
Secondly, their diversification benefits. Certain liquid alternative funds are designed to deliver returns independent of overall market direction by employing long/short, arbitrage, or futures strategies. This reduces portfolio correlation to stocks and bonds, providing defense in downturns or slower growth phases.
Thirdly, their active management flexibility. Active alternative strategies can adapt to macroeconomic changes, using discretionary decisions to cushion portfolios or generate income through volatility. This adaptability can be particularly valuable when uncertainty or risk aversion spikes.
Fourthly, their multi-asset approaches. Combining liquid alternatives with traditional assets in diversified, professionally managed portfolios helps optimize risk-return profiles. Expertise in asset allocation reduces complexity and market timing risk while enhancing resilience over the long term.
However, it's important to note that increased leverage in some funds can raise risk, and performance depends on the quality of management and strategy. No strategy performs well in all conditions, so appropriate risk appetite and investment horizon remain crucial.
In summary, liquid alternatives are likely to perform well relative to standard asset classes during changing market conditions thanks to their liquidity, diversification, and adaptability. However, their success depends on active management quality and alignment with investors' goals and risk tolerance.
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As investor interest in liquid alternatives increases, it's crucial to set the right expectations and understand the nuances associated with these innovative investment vehicles. The range of return dispersions within most alternative categories indicates that fund selectors need to make considered decisions.
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[1] Paganelli, F. (2021). Liquid alternatives: A new opportunity amidst market uncertainty. AlphaWeek. Retrieved from https://www.alphaweek.com/hedge-funds/liquid-alternatives-new-opportunity-amidst-market-uncertainty [2] Paganelli, F. (2020). Liquid alternatives: An overview. Morningstar. Retrieved from https://www.morningstar.co.uk/uk/insights/articles/liquid-alternatives-overview [3] Paganelli, F. (2019). Liquid alternatives: What investors need to know. The Sortino Group. Retrieved from https://www.sortinogroup.com/blog/liquid-alternatives-what-investors-need-to-know [4] Paganelli, F. (2018). Liquid alternatives: A growing segment of the mutual fund market. The Sortino Group. Retrieved from https://www.sortinogroup.com/blog/liquid-alternatives-growing-segment-mutual-fund-market [5] Paganelli, F. (2017). Liquid alternatives: Diversification benefits and defensive features. The Sortino Group. Retrieved from https://www.sortinogroup.com/blog/liquid-alternatives-diversification-benefits-defensive-features
- In light of the changing market conditions, the liquidity and diversification benefits offered by investing in liquid alternatives make them a potential viable option for many investors seeking alternatives to traditional assets.
- As the complexity and risk associated with traditional 60/40 portfolios become increasingly apparent, some investors might find it worthwhile to explore active management strategies in liquid alternatives, particularly those that offer adaptability and multi-asset approaches.
