Historically, alternative investments, such as hedge funds, have offered return enhancement, risk mitigation and correlation benefits to a diversified investment portfolio, but many investors have been unable to access these investments due to high minimum investment hurdles and high qualification standards. Even those who overcome these obstacles face subsequent illiquidity, special tax procedures and opaque investment reporting. As a result, advisors have only been able to provide the potential benefits of alternatives to a select sub-set of their client base.
The solution for a more broad-based asset allocation model lies in “liquid alternatives.” Liquid alternative mutual funds may offer liquidity, low investment minimums, no investor qualification standards and the general ease and familiarity of mutual fund structures.
The growth and availability of liquid alternative mutual funds also allow advisors to rebalance client portfolios at appropriate intervals. Efficient rebalancing offers advisors the flexibility to use alternatives within model-based portfolios as well.
The challenge is how to introduce hedge fund behavior—such as risk mitigation and increased diversification—into a liquid portfolio of traditional asset classes. Many existing choices are single-strategy, single-manager mutual funds, and selecting appropriate single-strategy hedge fund managers is a labor intensive process.
In lieu of investing in one specific hedge fund strategy, some advisors have chosen to create a basket of varying single-strategy, hedge fund-like mutual funds. Additionally, over the last few years, funds have been developed to incorporate multiple managers within one fund or portfolio. Regardless of which direction investors pursue, rigorous due diligence is required.