In Europe, the original UCITS framework for mutual funds came into effect in 1985. The regulations have been continuously developed since then. Hedge funds started using the UCITS format in earnest after the financial crisis when many investors wanted onshore, regulated vehicles. Also in the U.S., liquid alternative products have been around for about a decade. Liquid alts are currently entering a second wave of evolution, as the quality and the access to the managers have increased over the past two years. The first wave was primarily long-only managers extending themselves into the liquid alts space. The second wave are hedge fund managers who are now willing to offer their products within this framework, which makes the liquid alts space much more interesting. In fact, AllianceBernstein for example has defined liquid alternatives in the U.S. as “hedge fund managers who have offered their strategy in a daily redemption environment.”
Although there have been large flows into the space it is still very concentrated across a limited number of funds. Participants at this Roundtable do not believe that investors fully understand their investment objective, how to allocate and source the allocation. So from that perspective, liquid alts are still in the infancy stage. It seems the majority of the advisors have tended to pick a few managers but still require more education to fully understand the benefits of the strategies and limitations. Education remains a challenge.
Education remains a challenge, also for institutions
But it’s not only just the retail space that doesn’t understand liquid alts; the institutional space doesn’t understand liquid alts either. It may also have to do with the way that people have been trained for such a long time to think about the investment process. They tend to think about things in terms of stocks, bonds, and “other”. And they think about the investment process from a long-only investment strategy or asset allocation, and not as a risk allocation or by the risk factors involved. That doesn’t mean that investors don’t construct hedges or that they don’t play around the edges with short strategies, but the reality is that in order to truly harvest some of these return streams in the liquid alternative space requires a dedicated long/short, or a distinct alternative-type of approach. And then you still need to combine them into different types of portfolios: just adding one liquid alt fund won’t do the job.
Performance has been very divergent for alternatives and in fact, much greater than it is in traditional asset classes. Selecting a traditional fixed income manager, their dispersion is relatively low. When you look at dispersion for along/short equity, multi-alternative, or non-traditional, the dispersions are very large. Therefore, understanding manager selection quality and access is really key. Probably investors are just at the start of getting to know the impact of the manager selection decision in alternatives.
Early stages means they bear risks
Therefore the development and application of liquid alts is still in the early stages. The early stages though means that it bears risk. We are not pointing here to the risk associated with the investment but rather to the fact that there are many firms rushing to the market to offer liquid alts. Sometimes those products can appear more like an experiment – they may be well-done, but sometimes they are not. As a starter, many strategies that can be done in a liquid format, but also a lot of them that can’t. Maybe we are about to enter a period where the market is going to tell us much more about how these liquid alts are really going to function. This Roundtable elaborates in great detail the risk dimensions of liquid alts.
On top, investors as well as product providers and distributors should really find out what the end client is exactly looking to get out of this alternative investment? Are you worried about market volatility? Are you worried about downside? Are you worried about improved diversification? Is it a return product? Or is it about fees or about structure?
This inaugural Opalesque Liquid Alternatives Roundtable was sponsored by Lyxor and tool place end of January 2015 in New York with:
Christine Johnson, Managing Director, Alternative Investment Product Development, AllianceBernstein
Andy Weisman, Chief Investment Officer, Liquid Alternatives, Janus
Richard Lindsey, Chief Strategist, Janus
Barry Seeman, Global Head of Derivatives Structuring, Aegon
Jared Cornell, Managing Director, Alternative Investments, Charles Schwab
John Grady, Chief Strategy and Risk Officer, RCS Capital Corporation
Will Hogan, First Vice President, Investment Management, Amalgamated Bank
Nathanaël Benzaken, CEO, Lyxor Asset Management
The Roundtable also discussed:
Why are insurance companies looking at liquid alts?
How to deliver liquid alts for a Taft-Hartley clientele and defined contribution plans?
Why should every LDI program be using alternatives?
How can you deliver value at an “okay” risk for size?
What are the three drivers of investment returns in CTAs?
Why are bigger sophisticated investors making now more risk-based investment decisions rather than asset-based decisions?
Why and when will investors pay investors several hundred basis points per year in costs for netting risk?
When will the 2 & 20 hedge fund fee model make the manager richer than the investor (60% vs. 40% of gains)?
What’s the Richard Petty school of investing?
Are fees an issue for 40 Act funds? Is liquidity an issue for liquid alts?
Did the Peso Problem resurrect as the Swiss Franc? And what does this mean to your risk management?
What’s the appropriate role and extend of due diligence required for successful liquid alts investing?
How to best educate the market on liquid alts? Which distribution channels work best?
The Opalesque Roundtable Series offers unparalleled intelligence on the most important global hedge fund jurisdictions and their players. The Roundtable Series is a free publication from Opalesque and is continually updated. Please scroll down to view the full selection of our Roundtables - covering the globe!