With volatility recently rearing its ugly head, more investors are looking for ways to diminish portfolio risks, such as liquid alternatives that provide hedge fund strategies in an exchange traded fund investment vehicle.
The asset class may offer the democratization of hedge funds, bringing once restricted strategies catered toward institutional-sized investors to the masses, writes John Authers for Financial Times.
While we have not experienced a prolonged bearish environment that would allow alternatives to shine, some investors hope that alts strategies would maintain a low correlation with traditional assets, like bonds and stocks, and provide some growth and protection in the next bear market, similar to what hedge funds did during the dotcom crash of 2000.
Potential investors should be aware that these types of investments are not meant as growth strategies to generate outsized returns in investment portfolios. In reality, these strategies are doing exactly what they were made for, diminishing volatility. Consequently, in bullish market conditions, the strategies may underperform, but if the markets turn, alts can shine.
Additionally, these liquid alts funds may be used as a much cheaper alternative for existing hedge funds. Robert Gordon, president of Twenty-First Securities, pointed out that liquid alts’ expenses are treated as tax-deductible, whereas hedge fund investors are taxed on nominal returns before taxes. Fees on alts funds are much lower than hedge funds, which may include a normal management fee and a performance fee of as much as 20% of annual gains.
Investors can take a look at ETFs that track a basket of alternative investment strategies. For instance, the newer PowerShares Multi-Strategy Alternative Portfolio (NasdaqGM: LALT), ProShares Morningstar Alternatives Solution ETF (NYSEArca: ALTS) and IQ Hedge Multi-Strategy ETF (NYSEArca: QAI). Specifically, ALTS employs long-short strategies, hedge fund replication, managed futures, global infrastructure, merger & acquisitions, private equities and Treasury spread investments. The actively managed LALT holds a combination of equities, along with financial future contracts, forward currency contracts and other securities. QAI provides a diversified mix of alternative strategies, including multiple hedge fund investment styles, such as long/short equity, global macro, market neutral, event-driven, fixed income arbitrage and emerging markets. [Alternative Investment ETFs Are Increasingly Popular]