One of the biggest contrasts between sophisticated investors in the US and their European counterparts is the use of liquid alternatives. Last year, US investors pulled a net $44 billion from liquid alts funds, while Ucits investors in Europe pumped in an additional $11 billion. It was the sixth year in succession for positive inflows into these nascent products in the region. Yet for US investors they have failed to catch fire.
Why is this? There are many reasons but the biggest has been the astonishing bull run in US equities in the post-credit crisis period. Over five years until the end of February, the S&P 500 has risen 93%, while the average liquid alt has generated just 16%. Where is the attraction in paying for protection when your domestic equity market is the envy of the world – a luxury Europeans haven’t had.
Not bad numbers
Although it’s easy to see their lack of appeal against that backdrop, the narrative is very different when compared with treasuries. Over that period the JPMorgan United States GBI has risen just 7.9%, delivering less than the sector average in each of the nine liquid alt categories.
Not only that but the volatility investors exposed themselves to has been comparable. The annualized standard deviation in treasuries is 3.6% which is exactly the same as the average liquid alt fund. This volatility is above categories such as multi strategy, bond strategies and market neutral, which are the standard bearers of this movement.
What’s more, the portfolios held up majestically in the fourth quarter of last year when fixed income markets were battered. The average liquid alt fund eked out a 0.6% gain over the quarter, compared with a 4.1% loss made by treasuries. The best sectors, market neutral and long/short, were up 2.1%.
This is only one period but the reality is that there have been few tough times for traditional investments in recent years. The taper tantrum was too short-lived to judge the ability of liquid alts to deliver.
Time will tell
A strong case can be made for looking at these portfolios as alternatives to your treasury allocation. It’s true that these vehicles don’t provide an income of note, but isn’t a total return more important? In a world where rate rises have gone from being a discussion point to a reality, investing in vehicles that are fundamentally designed to ride out the tough times has some real allure.
Quite rightly there is some skepticism – liquid alts could just be another fad that balloons, blows up and fades away. However, the interest from investors at our Professional Buyers Retreat in New York last month was palpable. So, with track records finally being established and returns delivered, could 2017 be a watershed moment for the vehicles? Probably only if markets experience lasting shocks.