AMFs are mutual funds and exchange-traded funds (ETFs) that, unlike alternative assets such as real estate, can be as easy to buy and sell as stocks and bonds. At the same time, liquid alts* — as they are also known — can provide investors some of the benefits of owning non-traditional assets.
How AMFs Function in a Portfolio
"What liquid alts offer you is an opportunity to look at different strategies with different time horizons," says Gerald Laurain, CFA, president of advisory services for First Horizon Advisors. "Basically, what you're hoping for is to get a stream of returns uncorrelated to assets you already own."
When a portfolio includes investments such as liquid alts that provide the potential to produce returns uncorrelated to conventional assets such as stocks, bonds and cash, investors may find it easier to ride out broad market moves, either up or down. Ultimately, liquid alts can help improve risk-adjusted returns.
"That's the theory," Laurain explains. As is the case with any investment, past performance is no guarantee of future returns and liquid alts aren't for every investor.
These mutual funds and ETFs may be well suited for investors who want diversification into alternative assets, but who aren't suitable for limited partnerships or hedge funds which are other popular ways to invest in alternative asset classes. Unlike these other options, liquid alts don't have minimum investor net worth requirements, call for hefty minimum investments, or have lockup periods during which investors can't withdraw funds. They can be bought and sold any day the markets are open and net worth requirements and minimum investment size are the same as for other funds.
AMF Limitations
These mutual funds have tended to generate their most superior relative performance in bear markets and in volatile environments featuring wide price swings. For most of the last several years, markets have trended up with generally lower-than-average volatility. In this environment, AMFs have generally not produced the superior relative returns that made them popular during and after the last major recession.
Investors who do decide to consider AMFs may want to apply some extra due diligence, Laurain suggests. "You always want to read the prospectus and find out what portion of it will be liquid," he says. "More than with plain vanilla investing, when you invest in mutual funds you have to know what they own."
Also, more than with plain vanilla investing, investors need to make sure the investment fits their risk tolerance, time horizon and investment objectives. AMFs may not be appropriate for every situation.
"I really don't believe that liquid alts are appropriate for retirement plan investors," says Robert Johnson, president and CEO of The American College of Financial Services, a financial education institution in Bryn Mawr, Pennsylvania. Most retirement savers are better-suited to low-cost index funds, he says.
While liquid alts do offer exposure to alternative assets and strategies similar to hedge fund operators, liquid alt managers are hampered by investors' ability to pull money out at any time, as well as regulations that limit their investments in illiquid investments, Johnson says. "The promise of liquid alts has simply not been realized," he concludes.
Laurain says liquid alts can play a role, however. "It's not part of your core holding," he says. "But we do have AMFs in certain portfolios. We will use a blend of active strategies, including liquid alternatives and passive strategies, including ETFs and index funds."
Investors who want exposure to alternative assets and strategies but don't have liquidity needs and can handle a longer time horizon may be interested in limited partnerships with longer lockup periods, Laurain adds.
The Future for AMFs
The securities legislation enabling liquid alts was passed in 1940 and they have been part of the investment landscape ever since. "The popularity ebbs and flows," Laurain notes. "In markets like we've had since 2009, it's been pretty much one direction — up — so the strategy has been to buy the S&P 500 and hold on. But if you get a downturn in the market, we believe some of the hedge strategies will outperform the long-only strategies and that will bring in a new crop of buyers."
There are some indications that AMFs could be coming into a new era of popularity. "Many of the alternative strategies benefit from higher volatility and higher interest rates," Laurain says. "And a lot of people think we're moving into an environment that's going to have higher rates and higher volatility."
* Because AMFs are registered investment companies under the Investment Company Act of 1940, AMFs are required to have daily pricing and redeemability of shares, unlike "hedge funds" hence the term "liquid alts".
