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PENSCO Blog

Fresh alternative asset insights and the latest news on real estate and private equity investing.

What Do Liquid Alternatives Really Deliver?

Package with a Fragile Sticker

  |  By Joseph Adams

Liquid alternatives have seen their fair share of media headlines lately. And the attention really isn’t surprising – in fact, the time to market these strategies has never been better. On the one hand, you have the word “liquidity” - a concept that has become extremely attractive in the aftermath of the 2008 financial crisis. And on the other hand, you have the word “alternatives,” which have been growing in popularity among both institutional and individual investors for some time now.

As demand for these two concepts grew, it didn’t take long for fund providers to put the terms together and develop products that could offer both “liquidity” and “alternatives.” And this proved to be a wise strategic decision on their part – assets in liquid alternative funds have grown significantly in recent years. According to Morningstar, as of June 2014 liquid alternative asset funds totaled $154 billion - more than quadrupling since 2008. 

So what exactly are liquid alternatives? The simple answer is that they’re alternative asset strategies in a mutual fund or exchange-traded fund (ETF) wrapper. Unlike most traditional alternative assets, they have little or no investor minimums and typically don’t have lockout periods where investors can’t withdraw their funds. In a nutshell, they’re fund providers’ attempts to give the average investor access to what was once only available to institutions and accredited investors. They aim to deliver private alternative assets returns in a publicly traded format. 

Sound too good to be true? It might be. By design, the underlying assets in liquid alternatives must also be relatively liquid, which precludes holding a lot of the alternative assets that are known for delivering strong returns. These funds are also legally bound by diversification requirements and leverage limits, making it impossible to get the same composition as private alternative assets.

With this in mind, it’s really not surprising that there have been significant performance differences between liquid alternatives and their private counterparts. A 2013 Cliffwater study demonstrated that liquid alternative returns have lagged private alternatives by an average of 1% annually. This might not sound like a lot, but compound those returns over time and in 10 years you’re looking at a 15% difference – nothing to sneeze at, particularly when your retirement savings are at stake.

At the end of the day it is all about trade-offs. As nice as it sounds to get “liquidity” and “alternatives” in one neatly wrapped package, there’s a real risk they won’t deliver what you’re expecting.  

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.