Liquid Alts — a Look Under the Hood
While liquid alts may protect against downside risk, the potential benefits and tradeoffs are equally fluid.
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Richard Rankin recently joined Fiera Capital’s U.S. division in New York as their Portfolio Specialist responsible for Alternatives. The Montreal-based Fiera Capital is a global multi-asset class investment manager with over USD $85 billion in assets under management. With the addition of the team from the former Larch Lane Advisors in September 2016, Fiera Capital has a premier liquid alternatives product offering. Richard was previously the Chief Marketing Officer for Eachwin Capital and Managing Director and Chief Operating Officer at Ardsley Partners. He was formerly the Managing Partner of Atheneum Capital and a Managing Director at Morgan Stanley.
Geoffrey Doyle is the Senior Vice President of Alternative Strategies and Director of Research for Fiera Capital. Geoff previously served as a partner and Director of Research at Larch Lane Advisors LLC. Formerly, he was the Head of Research at Safra Asset Management and Director of Research and Head of Portfolio Management for Auda Advisor Associates. Previously, he worked with the debt capital markets group of UBS in New York and London.
Mark Jurish currently serves as Executive Vice President and Head of Hedge Fund Investing and Seeding Strategies for Fiera Capital. Previously, Mark served as the Chief Executive Officer and Chief Investment Officer or Larch Lane Advisors LLC. He acted as Managing Director at Paloma Partners and worked as a specialist in financial investment modeling and management consulting at Skadden, Arps, Slate, Meagher and Flom and with Arthur Young & Company.
Christopher P. Skroupa: What is a liquid alternatives (aka “liquid alts”) fund?
Mark Jurish: Broadly speaking, liquid alternative mutual funds are investment vehicles designed to generate returns exhibiting low correlations to traditional investments, including stocks and bonds. Liquid alts can provide access to top-tier hedge fund managers that employ diversified investment strategies including, but not limited to, long-short equities, global macro investing and CTA strategies.
Richard Rankin: Yes — liquid alternative mutual funds aim to provide investors with diversification and downside protection through exposure to alternative investment strategies. These funds may be suitable for a wide range of investors that are seeking diversified exposure in a more liquid and transparent vehicle than many traditional hedge funds can or will provide.
Jurish: Hedge fund managers employ a wide variety of strategies to seek profit from global markets. Some focus on shorter-term opportunities, others on longer-term. Some invest in a particular asset class, such as individual equities; others invest in futures contracts across a broad set of global markets. There are now liquid alternative mutual funds that focus on a narrow set of strategies, and other “multi-strategy” liquid alternative funds that invest in a broader, diversified opportunity set.
Skroupa: Why should investors consider investing in a liquid alts fund?
Rankin: Many investors are seeking investment solutions that can help smooth out the volatility that occurs in certain market cycles. A hedge fund may, in some circumstances, provide a form of “portfolio insurance” from overexposure to directional strategies. Currently, rich equity prices and low absolute returns on bonds and in the short term money markets are causing some (though not all) investors to take on more risk in pursuit of returns. A portfolio comprised of hedge fund managers with complementary but uncorrelated strategies is one possible solution; and if you can obtain that through a single vehicle which offers daily liquidity, even better!
Jurish: More and more, we believe retail investors need sources of return other than traditional equity and bond markets to help them meet their investment objectives. For decades, institutional investors have used hedge fund strategies to fill that role. However, hedge funds have been generally unavailable to typical retail investors due to net worth requirements, high investment minimums and limited liquidity. Hedge fund managers have responded to investors’ demand for low minimum, low fee, high quality daily-liquidity choices. Some have begun to offer their strategies directly in a mutual fund structure or to serve as sub-advisers on multi-manager mutual funds.
Skroupa: So far, performance in general has not been stellar. What is your outlook in 2017 and beyond?
Jurish: Hedge funds as an asset class have underperformed both on a relative basis versus their historic returns and, more prominently, versus equity markets over the past several years. We believe a significant portion of that underperformance was due to the fact that equity markets have been in a sustained “bull market” where correlations between individual equities have been generally high. As a result, many hedge funds have struggled, especially on the short side of their portfolios.
As we return to a more normalized environment, with rising interest rates and tighter monetary policies, these higher correlations may break down and enable hedge funds, which utilize a more fundamental approach to security selection, to once again offer attractive risk-adjusted returns. In other words, a number of benchmark indices, even those comprised of fundamentally expensive stocks, have gone up as “rising tides lift all boats.” As central bankers’ policies shift this trend may reverse and we may revert to more normalized investment cycles.
Geoff Doyle: In evaluating performance, it may make sense for investors to consider results from a portfolio-wide perspective. Even if hedge funds have not delivered stellar results on a standalone basis, if they are providing the investor with returns that are uncorrelated to higher risk components of their portfolio, they may be dampening portfolio volatility and improving the investor’s risk-adjusted results. Some investors are happy to accept this trade-off due to the potential diversification benefits over time.
Rankin: If you ask five investors for their outlook, you’ll quite likely get six opinions. When the market outlook is hazy, as it currently appears to be, one investment solution option is to be market agnostic — select managers who have demonstrated performance through many market cycles and whose primary focus is on generating returns rather than aggregating assets. Essentially there’s always an opportunity to be capitalized on somewhere. Investors need to be in position to do so.
Jurish: We believe there is reason for optimism going forward. At some point, investors will be more discerning with regard to valuations and expected forward looking multiples. When that happens, we believe there will be more winners and losers, which is an environment that is better for the average hedge funds.
In addition, while the overall hedge fund market had grown, despite poor performance, most of that growth has been captured by the larger hedge fund managers, while smaller, “early-stage” funds have struggled to raise assets. These early stage hedge funds tend to invest in smaller, less well-covered securities. In an environment where there is more dispersion between stocks because the market is not going straight up, there should be opportunity for the smaller hedge funds to find real value.
Skroupa: How do you deal with the liquid part of a liquid alts?
Jurish: By definition, liquid alternative mutual funds offer daily liquidity. There are some alternative strategies, including convertible bonds and other less liquid instruments that are being employed by some funds. We think it critical that a liquid alternatives mutual fund ensure that the underlying securities it owns can be liquidated quickly and without significant market impact. As a result, many of the more liquid alternative strategies, like global macro, CTA and long-short listed equities trading, have been commonly utilized.
Doyle: As an additional benefit, these relatively liquid global macro, CTA and market neutral equity strategies have tended to be among the least correlated strategies to the stock market over time, whereas certain less liquid strategies, such as distressed, have historically correlated to stocks. By focusing on the “liquid” aspect of liquid alternatives, investors may also be increasing their likelihood of better accessing the “alternatives” side of things.
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None of the commentary contained herein should be considered an investment opinion or recommendation; any decision to invest should be made in consultation with your investment professional and based on thorough research.
