Liquid Alternatives

Publication Date :

12 Jul, 2024

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Table Of Contents

What Are Liquid Alternatives?

Liquid alternatives are a class of open-end funds that invest in different types of investments. It is also referred to as liquid alts. The main purpose of these funds is to act opposite to the traditional investment strategies and diversify the portfolio rather than a "buy and hold" strategy.

The dynamic liquid alternatives investments are a combination of traditional and hedge funds but with enhanced liquidity. They primarily include mutual funds or exchange-traded funds (ETFs) that include lower minimum investments. Also, it provides exposure to the different alternative investment strategies that offer daily liquidity to investors, which is otherwise not possible.

What Are Liquid Alternatives?

Liquid alternatives are an investment strategy or fund that aims to diversify the existing assets and investments. They are akin to mutual funds or exchange-traded funds (ETFs).
This fund is a combination of traditional mutual funds and hedge funds. It tries to mitigate risks with specific strategies leading to maximum returns.
Some of the popular strategies include option trading, long-short equity, event-driven, macro trending, equity hedge, and others.
Others include market-neutral funds, multi-alternative strategies, managed futures, and investments in non-traditional bonds.

Liquid Alternatives Explained

Liquid alternative (alt) funds are investment strategies that provide daily liquidity to mutual funds and ETF holders. It enables diversification in different asset classes and cushions against market volatility. Also, with this fund, it is possible to take short as well as long positions (buy and sell) across stocks, bonds, and other asset classes. For instance, a person may invest in an index fund and, likewise, trade options. As a result, investors can easily hedge the market risk associated with open-end funds and trade-offs with liquid alt investments.

The mechanism of liquid alternative funds is a hybrid of two popular investment strategies (mutual funds and hedge funds). Here, in mutual funds, investors would invest and hold it until maturity. As a result, they were able to reap the long-term benefits associated with it. However, during market fluctuations, they were not able to adjust the portfolio or mitigate the risk. Also, the net asset value (NAV) witnessed a colossal breakdown. In contrast, liquid alts are a savior for such risks.

Liquid alts have a format similar to a mutual fund but with more liquidity. This means that investors can expect all the benefits of mutual fund, such as transparency, investment levels, and others. However, the addition occurs in the degree of governance. Here, assets within these funds are structured and revised frequently to adjust to market conditions. Examples of liquid alternative strategies include event-driven global macro trading, options trading, equity hedges, systematic trends, and others.

In addition, this fund utilizes different liquid alts methods to hedge the risk. A few of them include long/short equity, investing in non-traditional bonds, and managed futures. Furthermore, market-neutral funds reduce systematic risk arising from overexposure in different industries and sectors. Similarly, with a multi-alternative strategy, investors can deploy two strategies at the same time to hedge risk.

Examples

Let us look at some hypothetical and real-time examples to understand them in a better way:

Example #1

Suppose Kevin has been a fund manager in the Cash-in mutual fund for around six years. During this time frame, he has a good client base with investments in various stocks and bonds. Kevin utilizes a long-short strategy on certain index funds. In other words, if he expects a stock to rise, he will buy (long) the quantities today and sell in a bullish market. As a result, the client (investor) still benefits from the investment. However, the liquid alts needed severe monitoring.

For instance, if Kevin wants to run his business efficiently, he has to keep an eye on the market and the volatility associated with it. If Company A stock is undervalued at the moment and has the potential to shoot its average price, Kevin would buy them when the price is low. Later, as the price reached the decided target, he would sell them. Likewise, the entire portfolio was taken care of. Moreover, the client did not have to hire someone separately or invest in stocks to avail of this gain. Kevin would deploy this strategy within the stocks in the index fund. However, it was not possible in an average mutual fund to trade frequently with stocks.

Example #2

According to a recent news update as of February 2024, Morgan Stanley Investment Management (IM) has launched its MS INVF Systematic Liquid Alpha Fund. This fund offers exposure to market-neutral factors with a certain level of liquidity and has little correlation to traditional assets. In addition, it intends to establish a third asset class between equities and fixed-income instruments. However, this fund will be managed by the Morgan Stanley hedge fund team.

Advantages And Disadvantages

Dynamic liquid alternatives play a crucial role in an investment program. The following are some of their advantages and disadvantages. Let us look at them:

Advantages	Disadvantages
It provides diversification in different asset classes and investment strategies.	The use of alternative assets has varied exposure that can lead to volatile situations in any way.
They have low minimum investments as compared to hedge funds.	The cost of these liquid alts comes with high fees (3% to 5% annually).
Liquid alts have a low correlation with assets, leading to higher returns from investments made.	These funds come with closure risks as they have a shorter life span.
They provide transparency and regulatory oversight of the assets within the fund.	Certain compliances with ETFs can lead to illiquidity or leveraged positions.

Liquid Alternatives vs Hedge Funds

Although liquid alternatives are derived from hedge funds, they have some differences. Let us look at them in brief:

Aspect	Liquid Alternatives	Hedge Funds
Meaning	It is a combination of traditional mutual funds and hedge funds.	A hedge fund is an alternative investment where investors pool money to invest in different asset classes.
Offering document	Here, investors receive a simplified prospectus that details the fund.	The offering of a private placement memorandum states the purpose of investment made in hedge funds.
Fees and access	It is lower than that of hedge funds.	Here, the management fees are high, and the investment requirements range between $1 and $5 million.
Liquidity	Investors can buy or sell assets whenever required.	In this case, the redemption period varies.
Leverage limitations	At least 300% of the asset coverage is necessary to maintain.	There are no leverage limitations, as it depends on the manager's call.

Frequently Asked Questions (FAQs)

What is the importance of liquid alternatives?

Liquid alternatives supply a high significance at times of liquidity and daily pricing. It synchronizes with the investment goals of the investors and adjusts likely. For instance, individuals approaching retirement can invest in these funds, which rise with inflation. Furthermore, it also provides financial security, creating downside protection from various market risks.

What is the liquid alternative index?

In general, the liquid alternative index refers to a metric that measures the performance of different alternative investments like ETFs, mutual funds, and others. Some of the popular liquid alts indexes include HFRI-I Liquid Alternative UCITS Event Driven Index, Wilshire Liquid Alternative Equity Hedge Index, Scotiabank Alternative Mutual Fund Index, and more.

What group of investors do liquid alternatives appeal to?

These investments primarily target retail investors aiming for asset diversification. However, in some cases, institutional investors and high-net-worth individuals also invest in this fund due to fewer regulations.