Manage Market Risk Exposure with Liquid Alternative ETFs | ETF Trends

Institutional investors, financial advisors and retail investors can all gain exposure to alternative assets through ETFs to ensure a portfolio is optimally diversified to withstand a variety of market conditions.

On the recent webcast, Liquid Alternative ETFs: The Institutional Perspective, Andrew McCollum, Managing Director, Greenwich Associates, dissected the inaugural survey conducted by Greenwich Associates on the use of liquid alternative ETFs by institutions to determine how those investment professionals are currently employing alternative asset classes and ETFs in their portfolios. The survey results revealed an evolving trend towards more extensive use of liquid alternative ETFs by institutional investors in specific situations.

“The intersection of ETF adoption and continued growth of alternatives could lead to a transformation of alternative investments in institutional portfolios,” McCollum said.

McCollum pointed out that liquid alternatives represent 4% or $882 billion of institutional assets, with the largest allocations residing among public funds, corporates, and endowments & foundations. Institutions also allocated approximately $47 billion to liquid alternative ETFs. The survey results showed that institutions are attracted to liquid alt ETFs because of their enhanced liquidity, improved portfolio diversification benefits and heightened transparency.

“Greenwich projects that, over the next 12 months, institutional investment in liquid alt ETFs will climb to $114 billion – roughly 2.5X current allocations,” McCollum added.

Salvatore Bruno, Chief Investment Officer and Managing Director, IndexIQ, also highlighted the growing demand for liquid alternatives in both the mutual fund and ETF categories. In 2018, around a combined $341 billion was invested in into the Morningstar alternative category for ETFs and Mutual Funds.

Liquid alternatives are vehicles that deliver exposure to alternative asset classes with daily liquidity, and investors can access these strategies in common vehicles likes closed-end funds, mutual funds and ETFs. According to the survey results, the hedge funds, real estate and private equity categories were the most popular liquid alternatives among institutional investors. Institutions mainly used liquid alternatives for transitions, achieving cheap beta, replacing long-term core holdings and occasionally for tax efficiency.

Bruno added that alternatives, particularly traditional hedge fund strategies, can potentially offer several diversification benefits to a portfolio. He specifically highlighted three major benefits, including lower correlation to equities and fixed income to improve diversification; lower beta to provide more volatility management and risk mitigation than traditional asset classes; and additional sources of alpha to contribute to overall portfolio returns.

Furthermore, many institutions are considering liquid alt ETFs in place of funds-of-funds, which account for 20% of overall alternative allocations. The survey participants noted that relative to funds of funds, liquid alt ETFs are seen as easy to use, liquid and more cost-effective.

Among the various liquid alternative strategies available, merger arbitrage strategies have historically demonstrated a low correlation to equities and a negative correlation to fixed income, according to Bruno. Additionally, a multi-strategy alternative ETFs can help mitigate manager risk more efficiently, historically resulting in more consistent returns over time.

For example, a Family Office with $1.5 billion AUM has used an IndexIQ merger arbitrage ETF to diversify away from equity and bond risk in a cost and tax efficient way to allow for more focus on individual stock and bond selection, according to Kelly Ye, Director of Research, IndexIQ. A $9 billion AUM third party investment manager and ETF strategist has used an IndexIQ merger arbitrage ETF for both volatility management as a bond surrogate because they felt that bonds were too expensive and didn’t want to put more money into an asset class that appeared to be fully valued at the time.

To help investors better manage risk and diversify a portfolio, IndexIQ has come out with a suite of liquid alternative ETF solutions, including the broad fund-of-funds IQ Hedge Multi-Strategy ETF (NYSEArca: QAI). QAI tracks 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.

The ETF offers a multi-alternative fund-of-funds approach in an ETF, without the multiple layers of fees and the mitigation of single-manager risk. On days when then S&P 500 Index was down 1% or more, QAI saw less drawdown 100% of the time since its inception

Additionally, the IQ Merger Arbitrage ETF (NYSEArca: MNA) is another popular liquid alternative strategy that employs a type of “directional hedge fund strategy” called merger arbitrage where the fund tries to capture the spread or difference between a stock’s trading price before a deal is announced and its eventual takeover price. On days when then S&P 500 Index was down 1% or more, MNA saw less drawdown 99% of the time since its inception

Financial advisors who are interested in learning more about liquid alts strategies can watch the webcast here on demand.