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Advisors Still Allocate ‘Far Less’ to These Funds Than Expected

A new report highlights advisors’ persistent lack of interest in liquid alternative funds.

In October, well before Covid-19 began rapidly spreading in China and then across the globe, Bill Kelly, the CEO of the Chartered Alternative Investment Analyst Association (CAIA), made a case for liquid alternative funds.

Liquid alts aim to deliver positive absolute returns in most market conditions and correlate little to stocks and bonds. With those attributes in mind, last fall was as good a time as any to consider investing in them. “There is a sense that the extended ‘risk-on’ phase of the stock market may be nearing an end,” Kelly told RIA Intel at the time.

Institutional investors have used liquid alts for decades but it seemed financial advisors were wrongfully ignoring them in October — and they still are, according to a new report.

Liquid alts are “exceptionally important to advisors who recognize their role as portfolio diversifiers” but use of the funds remains low, according to a new report from Cerulli Associates, a Boston-based research and consulting firm.

“Advisors allocate far less to alternative exposures than would be expected, especially given the increased availability of the products and advisors’ reported need for diversification and downside protection,” Daniil Shapiro, an associate director at Cerulli, said in the report.

Liquid alternative funds can charge above-average fees and diversify revenue at asset managers. But the uptake by financial advisors has been so weak that Cerulli is recommending that asset managers focus on developing funds in the future that are less expensive with “more coherent exposures that are easier to explain and position to advisors,” and avoid riskier segments. “Alternative product manufacturers should take a page from the passive management playbook and compete on simplicity and costs as opposed to a capabilities arms race,” Shapiro said in the report.

Most liquid alts strategies currently come in mutual funds. But exchange-traded funds, known for their simplicity and low cost, could be a strong distribution vehicle for liquid alternatives, according to Cerulli.

The reasons Shapiro gave for the persistent lack of interest in liquid alts are some of the same Kelly and others described last fall: costs, investor performance chasing resulting in subpar returns, and complexity of the strategies.

In addition to simplifying funds and lowering their costs, improving advisor education on liquid alts could also increase their usage.

The liquid alts universe (including commodities and other categories) included $804 billion in assets at the end of 2019. U.S. hedge-fund-like liquid alts accounted for $314 billion in assets at the end of last year, a decline from $410 billion in 2014.

Asset managers still cater to institutions, but figuring out how to get alternatives to retail investors is an objective of many. In 2007, retail investors accounted for 37% of the addressable market for alternative investments. Last year, they accounted for nearly half the market (48%) for private equity, hedge funds, and more.

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