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Liquid spin

11 July 2014 By Richard Beales

Pouring liquidity into alternative assets is an unsavory concoction. U.S. mutual funds that deploy hedge-fund-like investment strategies are supposed to give regular Joes and Joannas a taste of investing styles usually reserved for the super-rich. The $140 billion industry, however, looks more like a way for managers and distributors to compete for assets – and fees.

Funds that both buy stocks and sell them short, for example, can provide positive returns however the market moves. Managed well, leverage and shifts between types of assets, like stocks and bonds, can amplify returns beyond what’s achievable with narrower strategies that don’t use borrowed money. Packaged within the rules of the Investment Company Act of 1940, these so-called liquid alternatives can be traded like any mutual fund and come with management fees of up to about 1.5 percent of assets, according to Citigroup, rather than the nearer 2 percent plus 20 percent of gains for full-fledged hedge funds.

Yet investment performance looks anemic even compared to hedge funds. Liquid alternatives have averaged 0.9 percent a year over six years against the HFRI fund-weighted index return of 2.3 percent annually, according to Barclays. The sector nevertheless increased assets 43 percent from 2012 to 2013, a much sharper gain than in the broader hedge fund world. And the funds remain popular, according to a new survey by Morningstar and Barron’s.

The appeal for money managers and firms that distribute funds is clear. Barclays reckons there’s a universe of investors worth $19 trillion which probably wouldn’t go into hedge funds directly but might put some cash in liquid alts. Meanwhile, retail investors more accustomed to index-tracking mutual or exchange-traded funds with expense ratios in the 0.1 percent range might be tempted to upgrade to ’40 Act funds that make managers perhaps 10 times as much. Steadier mutual fund fees may also hold greater appeal for investors in asset management firms than volatile performance payouts.

There’s a faddish aspect to the offerings, however. Another market freeze like the one in 2008 could reveal the funds to be less liquid than they seem. Anthony Scaramucci, founder of $10 billion fund-of-hedge funds firm SkyBridge Capital, likens the idea of combining liquidity and hedge-fund strategies to drizzling vinegar over ice cream. The ingredients may be enjoyable separately, but not together. Investors shouldn’t be too eager for a taste.


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