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The Rise of Liquid Alternatives

The rise of liquid alternatives funds appears to have peaked. The chart below shows the annual asset levels and net flows of open end liquid alt funds since their introduction during the Financial Crisis. While the number of liquid alts continues to rise, total assets for these products have started to decline and cash flows have turned negative.

The clear driver behind the waning interest in liquid alts is performance. The chart below compares the average annual returns of liquid alt funds in the marketplace to the annual returns of the S&P 500 Index since 2007. Clearly in the bull markets following the Crash, liquid alts have significantly and consistently lagged the traditional benchmarks. This loss of the upside has clearly worn on some investors and advisors, perhaps even those that are using alts primarily as a risk-management tool.

What also may be of concern to those considering liquid alts options is performance relative to the long-only market. Since 2007 the correlation of the average annual returns of liquid alts to the S&P 500 has been 0.89. When the market has gone down, liquid alts have generally followed, although with exceptions, throwing into question the value that many of these funds may add as a diversifier during a more severe correction. This increases the importance of due diligence in selecting the right alt offering.

Whether liquid alts regain their allure will likely be determined by their performance in the next bear market. But for now they offer an informative case study of the genesis and development of a new product idea.