Alternative investments such as hedge funds, private REITS, and MICs, have been growing in popularity over the past two decades. Savvy investors like them because of their low correlation with traditional stocks and bonds. That allows for diversification and capital protection during turbulent times.
Alternatives (or “alts”), however, are not available to everyone. Most of these products are closed to the general public. They are only allowed for qualified investors. These usually are high net worth individuals or institutions that meet certain legal criteria. Two reasons for this restriction are risk and lack of liquidity. The latter is the main weakness of most alts.
For example, real estate investments have low liquidity by their nature. And hedge funds usually impose contractual limits for capital retirement.
Liquid alts: Non-traditional investment categories
So alts are now more accessible to the general public. With that in mind, a hybrid investment known as “alternative liquid funds” is available. The main feature of liquid alternatives is their ability to use non-traditional products and strategies. At the same time they offer the liquidity of a mutual fund or an ETF.
Like pure alternatives, liquid alts can invest in non-traditional categories like real estate and infrastructure. Liquid alternatives can also use hedge fund-like strategies such as market neutral and long/short positions. Also, these funds are allowed to use leverage. They have low restrictions for short selling and borrowing. At the same time, they are more affordable than alts and can be traded in the secondary market. And that is just like a traditional fund.
Performance fees
Some investors avoid alternatives because of transparency concerns. Most alts are part of the exempt market. That means they can be offered without the protections of a prospectus. Liquid alts, however, follow a regulatory regime that has disclosure and reporting obligations. For investors, those obligations are similar to that of mutual funds.
But there is one caveat. Their management fees tend to align with those charged by conventional funds. But liquid alts charge a performance fee. And that fee works in the same way as hedge funds (like the “2 and 20 rule”). Is this extra cost worth the expected performance of a particular fund? Investors need to weigh that out.
Enthusiastic response
Alternative liquid funds took off in the US and Europe as a response to the financial crisis of 2008. Investors were desperate to find options that could protect against volatility. They wanted options that were not the exclusive domain of the wealthy. Canada, known for its more conservative approach, did not follow suit. Well, that changed in January of 2019. And Canadian investors have been responding with enthusiasm. There are now more than 100 funds available to investors in this country.
Then, of course, there is the COVID-19 financial crisis. It certainly didn’t take long, but Canadian liquid alts are currently being put to the test. When the stock market peaked during 2019, they saw little movement. The big question is whether they will deliver during the uncertainty of these current times. That is something for investors to monitor.
Can liquid alts still deliver?
Most liquid alternatives in Canada are offered by the banks’ wealth divisions. Larger fund companies also offer them. CIBC Asset Management is one of the originals, introducing the CIBC Multi-Asset Absolute Return Strategy fund.
Dynamic Funds has several choices in terms of industry focus and strategies. Their Alpha Performance II Fund performs well. But their Real Estate and Infrastructure fund has gone through a sharp decline in value.
High liquidity and transparency
Since these products are new in Canada, there is very limited data to evaluate their performance. They are not for investment novices. It is important to factor in the level of sophistication required to understand the strategies employed by some of these funds.
However, liquid alts are a product that allows for participation in the alternative market. That’s the bottom line in all of this. They offer high liquidity and transparency. And these are stressful times. Liquid alternatives should be seriously considered by any investor looking for superior returns and capital protection these days.
Legal Disclaimer: the contents of this article are for information purposes only and are not intended to provide any form of financial or investment advice.
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A business professional turned writer, Ricardo has a passion for presenting complex ideas in a reader-friendly way. He has worked for blue chip corporations in Canada, ran a restaurant franchise in Venezuela and developed a papaya farm in the tropical jungles of southern Mexico.
His education includes an MBA, specialized financial training, and a variety of professional writing courses from the University of Toronto. He has published personal finance articles in both English and Spanish.
Ricardo lives in Toronto with his wife and daughter.
