Creating a strong investment portfolio means diversifying investments to hedge against volatility and loss. One way to do that, especially for investors who are unable to access hedge funds, is with liquid alternatives. Here’s what you need to know about this type of security. A qualified financial advisor can help you decide whether liquid alternatives are a wise addition to your portfolio.
What Are Liquid Alternatives?
Put simply, a liquid alternative investment (or liquid alt) is a blend of lucrative hedge fund management strategies with the daily liquidity of a mutual fund. Liquid alts can be a substitute for traditional hedge funds, though they are often much more accessible for everyday investors.
Nearly all liquid alternative investment funds were created after the 2008 global financial crisis. The idea was to provide retail investors with portfolio diversification while also helping protect against downside, with daily exposure to a variety of alternative investment strategies. Done properly, this could reduce long-term risk and limit overall investment volatility.
Alternative investments include a variety of assets that don’t fall into either the bond or long stock categories. This may mean real estate, commodities, derivatives, private equity, distressed debts or even fine art. However, these investments aren’t typically very liquid in nature — if an investor needed to sell off very quickly, he or she would have a much tougher time with a fine art or real estate asset than a more mainstream stock holding.
This is where liquid alternatives aim to come in. These investments are broadly accessible to investors and offer daily liquidity, like a mutual fund or exchange-traded fund (ETF). This means that they can be bought or sold on a daily basis, as opposed to traditional alternatives — many of which are redeemed on a monthly or quarterly basis, if that.
Examples of Liquid Alternatives
Many of these categories have a low correlation with traditional stocks and bonds. Instead, they tend to closely parallel the strategies implemented by hedge fund managers.
Investing in Liquid Alternatives
Before an investor considers adding a liquid alt to their portfolio, there are a couple things to keep in mind.
The first is that liquid alts tend to have higher fees than average mutual funds. Though these alternate investment vehicles offer similar liquidity to your everyday mutual fund, they tend to have higher fees than those mutual funds. Some investors may find this added cost worthwhile, since liquid alts employ many of the strategies employed by hedge funds.
Next is that liquid alts typically have lower investment minimums. While many hedge funds are inaccessible to everyday retail investors, liquid alts tend to have lower investment minimums. This may put these alternative investment vehicles within reach for lower-income or net worth investors.
Lastly, it’s important to note that many critics of liquid alts point to their age as an added risk factor. Since the majority of these investments were only introduced post-recession, they have largely benefited from the bull market we’ve had since. They simply haven’t been around long enough for investors to know how they will perform in a big market downturn.
The Bottom Line
Liquid alternatives combine the daily liquidity of mutual funds with the high-performing strategies of hedge funds. They do so without the large income, net worth and minimum investment requirements of most hedge funds, putting them on the radar of many retail investors. Liquid alts are a fairly new investment vehicle, however, and haven’t given us much data regarding their downturn performance. They also have higher average fees than comparable mutual funds, meaning that investors will need to weigh their cost with benefits such as portfolio diversification.
Tips for Investing in Liquid Alternatives
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