The positive for investors between liquid and illiquid comes where the investment vehicle is liquid – sometimes listed – but the underlying asset is illiquid. Lowcock, for instance, has exposure to aircraft leasing which he would not necessarily recommend to anyone individually but with an 8% yield is attractive when in the right liquid wrapper.
Investors – and regulators – want structures that give them greater regulation, transparency, access and liquidity as opposed to the more opaque hedge fund structures of old. The way of the alternatives investment world is that this can only be achieved through liquid structures, namely Ucits vehicles.
A liquid alternative allocation also helps investors not to become forced sellers at the wrong time, as witnessed by the fund groups’ knee-jerk reaction when gating their property funds last year.
“One of the functions a well-chosen alternatives strategy offers is around drawdown containment when asset classes become highly correlated,” said David Greene, from the Multi-Asset Solutions team at Amundi Asset Management. “Clients often panic during market sell-offs because their loss tolerances are exceeded. Ultimately, an allocation to a liquid alternative can help investors to stay the course and not step out [of the market] at the wrong time.”
There is a greater acceptance of alternative investments in a regulated structure and it seems that for some at least money is following the sentiment.
Phil Smeaton, CIO at Sanlam Private Wealth, holds 25% in alternatives even for the most cautious investor, largely through absolute return funds though he also owns some plain vanilla structured products.
Mona Shah, head of collectives’ research at Rathbones, follows the same principle, saying: “The highest-risk clients are unlikely to hold these because, in theory, they tend to have a long time horizon and can therefore withstand more volatility. At the lower-risk end, we would probably be thinking along similar lines [to Smeaton] and for more balanced clients, potentially somewhere between 7% and 15%, but we’re not prescriptive.”
How much is allocated to alternatives will depend on what investors are trying to achieve. The question to ask is: ‘Do you want to maximise returns or maximise the probability of your outcome?’.
The liquid alternative funds that are ultimately chosen for a portfolio depend on the role they are expected to play and how granular a portfolio manager’s fund selection and asset allocation are. Do they sit in an ‘alternatives’ allocation? Are they included under a ‘diversification’ heading? Ultimately it is all about the risk/return profile you want from this specific allocation.
Mike Allen, CIO at Momentum Global Investment Management, is increasing his allocation to liquid alternatives as an additional, tactical way of allocating to traditional asset classes.
“To date we have invested in strategies that aim to extract risk premia within equity markets but are overall market neutral, and within the fixed interest market for something that doesn’t have a duration bias or a credit bias, something that looks to play across government rate curves, currency, etc.,” he explained.
Anecdotally, alternatives are taking a greater share of a portfolio’s asset allocation; in reality, it is the same picture.
Analysing data from Morningstar, our Last Word research team shows that at the end of March 2005, total investment in European-domiciled funds stood at €2.6trn of which 1.9% was in alternatives.
A decade later and the respective figures are €7.8trn and 5.6% - the total investment pot has grown three times its size in 10 years, while over the same time period three times as much money is going into liquid alternatives.
And we’ve only just begun…
Liquid alternatives are either defined by what they are not (equities, bonds); or by what they set out to deliver (cash+ returns, income); or by the service they offer a portfolio (insurance, risk mitigation). Diversification and a lack of correlation are two themes that run through all of these.
Davide Cataldo at Amundi Asset Management, expressed a slightly broader view: “If it’s performing a function that is lowly correlated, or uncorrelated to other core parts of your portfolio, you can think of it as alternative.”
The role liquid alternatives have will differ depending on the nature of risk in a cautious, balanced or aggressive portfolio. During our discussion, liquid alternatives were used because investors are wary of equity risk and expense, looking to diversify bond risk, or, lower down the risk scale, looking to return more than cash and inflation.
Another key consideration behind alternatives is the predictability of returns and the nature of the predictability required - for income, or protection, or beta+ returns - that will influence the type of alternative investment made.