A Hedge Fund Manager’s View on Liquid Alternatives

Included below is an excerpt of Andrew Beer’s article in WealthManagement.com:

There’s something amiss in the liquid alts space.

After years of stellar growth, adoption of liquid alternatives at wirehouses ground to a halt last year, according to a recent study by the Money Management Institute and Dover Financial Research called Distribution of Alternative Investments through Wirehouses (2016). Consequently, despite growing risks in 60/40 portfolios, most retail investors are significantly underinvested relative to target allocations. On top of this, some big players that were early adopters of liquid alternatives are rethinking that move strategically.

“Generation one” of liquid alts had three major issues:

  1. Hype versus reality
  2. Asset allocation versus returns chasing
  3. Fees

Advisors and their clients are looking for proven, predictable outperformance relative to a benchmark (bucket), low fees, and a simple structure.  With that in mind, here are a few recommendations:

First, focus on (realistic) outcomes. Second, fees matter. Finally, link the product choice to the asset allocation objective.

Based on those three criteria, here’s a prediction: We’ll see a resurgence of hedge fund replication. Why? Early skeptics had hedge fund franchises to protect. Today, however, institutional investors acknowledge that simple replication strategies have consistently outperformed actual hedge funds over the past decade (in some cases, by 100 bps or more per annum with much lower drawdowns in 2008). Importantly, the strategies can work seamlessly within 40 Act funds so performance doesn’t suffer. In addition, all-in expenses should be very low, e.g., no short interest costs or acquired fund expenses for futures-based portfolios. Plus you also get “sector-like” predictability, since replication is based on large pools of funds, not the hot dot. In this particular case, there’s a strong argument that imitation truly is better than the real thing.

Click here to access the full article

June 30, 2016