In a climate where equities and bonds increasingly have a tendency to flock together, it leaves investors searching for products which not only diversify a portfolio, but also have a suitable underlying liquidity profile.
Last November, a Greenwich Associates survey projected US institutional investors were set to double their allocations to liquid alternative ETFs. ETFs make-up just $47bn of the $882bn liquid alts space.
However, the picture is less promising in Europe. As Henry Cobbe, head of research at Elston Consulting, said, the rise of liquid alts can be traced back to the Global Financial Crisis (GFC) in 2008.
“In the US, the tradability of the ETF format meant that a broad range of liquid alt ETFs were launched, providing access to asset classes such as gold, commodities, and property securities, as well as long-short and more sophisticated active or systematic investment strategies packaged up within an ETF.”
Many such products were typically available only via less liquid vehicles, Katie Magee, beta investment specialist at JP Morgan Asset Management (JPMAM), suggested. But the innovation inherent within the ETF structure means the “variety of liquid alternative options has also increased”.
Distinguishing between alternatives
Cobbe explained that under the liquid alts banner, there are two types of products. The first offers exposure to alternative asset classes while the second is aimed more at those looking for alternative asset allocation strategies.
In the UK during the wake of the GFC, he noted there were many ETFs launched in the first area, particularly with gold, commodities, property, listed private equity and infrastructure.
“In this respect, the growth in depth and breadth of liquid alts has been impressive, particularly in the commodities and property sectors,” he added.
However, in the latter area of alternative asset allocation strategies, the ETF format has not proven to be so popular with absolute return funds, systematic trading strategies, funds of funds and funds of structure products all remaining popular in mutual fund formats rather than in exchange-traded products.
Cobbe highlighted four reasons for this failure for liquid alt strategy ETPs:
- In the UK there was less familiarity with ETFs as a fund format, which were and are generally perceived to be, first, single asset-class building blocks, rather than strategies; and second, index-tracking, rather than active
- As a structural diversifier to a portfolio, there seemed little need for investors to trade liquid alt strategies on an intraday basis. A traditional fund format would do
- In the advisory market, most platforms were not configured to trade or hold ETFs, meaning that funds were the structure of choice from a distribution perspective
- Where liquid alt strategy ETPs have been launched, the actual investment strategy has failed to deliver
As more liquid alts come to market, this sluggish take-up on the strategy front is likely to alter, however. One of the most significant moves in this respect came with JPMAM’s entry into the UK market with its range of active ETFs such as the JPM USD Managed Futures ETF.
Magee certainly believes there is momentum behind alternative asset allocation strategy ETFs and said the recent market volatility has highlighted their attractiveness as diversifiers.
“We would expect interest in these diversifying strategies to continue to increase,” she added.
Yet, as Cobbe pointed out, JPMAM’s JPMorgan Equity Long-Short UCITS ETF, having launched in September 2018, actually delisted in June after failing to gather significant assets. Similarly, the UBS HFRX Global Hedge Fund Index which opened in June 2012 closed four years later.
“The more complex liquid alt ETFs launched into the European market, have had far less success, and have ended up in the ETF graveyard,” he added.
Ben Seager Scott, chief investment strategist at Tilney, is yet to be convinced that the current crisis will lead to a resurgence of interest in liquid alts generally.
“If anything, I think we saw more interest prior to the COVID-19 outbreak,” he added.
Evolution of the landscape
Historically, Seager Scott suggested, there is more interest in what he calls the “more esoteric” asset classes late in the cycle.
But he added: “That said, this is really a natural evolution of the ETF landscape. For a multi-asset investor, ETFs started in equities, now we have many more options in fixed income, so the alternatives element of portfolio construction seems the natural next step.”
As it stands, the broad range of what is covered by liquid alts may be a hindrance to their take-up, Magee suggested
“It is important for investors to understand what they are buying and the role particular investments will play in a portfolio.”
“This becomes particularly important for alternative investing as there is a very broad range of strategies available. Each will have its own unique risk and return profile.
“In fact, just like in more illiquid alternative strategies, there can often be a low correlation across portfolios, even within the liquid alternatives bucket.”
At present, Seager Scott suggested the appeal of liquid alts lies largely in the institutional sphere rather than with retail investors.
“For broad adoption, it would probably need to be a ‘mainstream’ player, supported by a large campaign to help educate those investors who may not be familiar with the area, and of course it will depend on what type of alternative investment space we are talking about.”
For Cobbe, the move into the mainstream needs a further push. “Where we do expect innovation is in index-tracking funds that can be held on platform and provide a transparent, liquid and systematic approach to delivering true diversification strategies, as an alternative to opaque, higher cost absolute return funds.”
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