Alternatives take center stage

The party people of Pamplona, ​​Spain, and liquid alternative mutual funds and ETFs (known as “liquid alts”) share a key trait. Neither can resist the stampede of a raging bull. For much of the past decade, an ever-increasing bull market led a wide range of liquid alternative funds to lag the gains posted by equities. These hedge fund-type products aim to profit from volatility and uncertainty.

Fast forward to 2022. As a result, these funds are posting respectable returns, quickly making up for lost ground. Meanwhile, outside of public markets, a whole new set of alternative investment options have emerged for advisors looking to capture the alpha generated by private markets. Let’s take a closer look at each segment of this diversified asset class.


Godot finally arrives
Many advisors have probably overlooked liquid alts because for years they have produced poor returns. These funds are designed for volatility, after all, or to create positive returns when stock and bond prices fall, which they weren’t doing. It’s a shame, because now people are probably realizing that exposure to liquid alts would have helped stabilize portfolios that have dipped underwater in recent quarters.

Certainly, some advisors (and retail investors) made the right pivot. After five consecutive years of net outflows, liquid alternative funds took in $31.83 billion in 2021, according to Morningstar. And the interest continues to grow. “Each category [of liquid alts] saw positive entries this year,” says Simon Scott, head of alternatives research at Morningstar.

He notes that “hedged equity” funds have captured the greatest amount of new funds. These funds hold stocks and also buy options contracts to act as hedges to offset market risk losses. Through the end of May, the category saw an additional $6.9 billion in net inflows. With $24.7 billion in assets under management (through mid-June), the JP Morgan Hedged Equity Fund (JHEQX) is the largest in the category, earning a five-star analyst rating and “Silver by Morningstar.

Trend-following funds, which follow a strategy using technical analysis of market price movements, also saw strong net inflows of $4.3 billion this year, “not surprisingly when you see how successful they have been,” Scott says. The group’s average fund increased by 22% through May this year, with some funds such as AQR Managed Futures Strategy Fund (AQMIX) and AlphaSimplex Managed Futures Strategy Fund (AMFAX) both increasing by more than 45% until the end of May. Scott adds that “the tendency to track bonds and commodities has been strong, especially for those with higher volatility targets and therefore may have higher leverage.”

Will market volatility continue for the rest of the year? With the Federal Reserve aggressively raising interest rates, high inflation creating economic strains and a growing possibility of a recession later this year, the answer would seem to be yes.

In the absence of a crystal ball on the direction of equity markets for the rest of 2022, advisors may want to explore another pair of liquid alternative categories: market neutral funds and long/short funds, which aim to provide stable (or at least more moderate) returns. negative returns) when stocks crash.


The Private Pivot
Advisors are also increasingly embracing alternative assets that trade in private markets, such as private equity, venture capital, private credit (also known as “direct lending”) and durable assets such as infrastructure.

In a February article published by Morningstar, titled “When History Rhymes”, Scott wrote that “while pension funds and longer term liability matchers have long incorporated these assets into their portfolios, more recently , a wider range of institutional investors, and even wealthy individual investors, have crossed over.

Tapping into private markets makes sense considering that many companies choose to remain private rather than face the scrutiny and regulatory burden of public entities. According to Morgan Stanley, companies have raised more money in private markets than in public markets every year for more than a decade.

But investing (or lending) in private markets has an obvious downside that liquid alternatives don’t: restricted liquidity. You can only redeem private market silver a handful of times a year at best, and sometimes not for five or seven years. These investments should therefore only represent a portion of a client’s asset base, the portion intended for longer-term wealth generation.

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