Growth of Liquid Alternatives

April 24, 2014

This week’s chart looks at the recent fund flows and the trailing twelve-month (“TTM”) percentage growth rate of liquid alternatives as of March 31, 2014. Over the past decade, private investment managers, traditionally associated with less liquid investments such as hedge funds, private equity, and real estate, have expanded their investment focus towards the creation of liquid alternative products that comply with the 1940 Investment Company Act in order to meet the demands of the rapidly growing defined contribution market.

Within the open-ended mutual fund universe, liquid alternatives have once again topped all other asset classes with the highest organic growth rate over the TTM period, up 39.5% as of March 31, 2014. Although this growth rate is impressive, liquid alternative assets only represent 1.3% ($149B) of the U.S. mutual fund universe, which has over $11 trillion in assets.

As the trend toward liquid alternatives continues to grow, investors should consider the potential implications and effectiveness of the newly designed strategies. ’40 Act funds must comply with restrictions not required by traditional hedge funds such as leverage limits, short-selling, and liquidity. In addition, the standard 1.5% and 20% hedge fund fee structure has to be adjusted within the ’40 Act universe; currently, the average management fee for liquid alternative funds is around 1.5%. Since the significant rise in the formation of liquid alternative products has taken off within the past few years, investors should be cautious before diving into the space as the next decade will be a testing ground for these strategies as to whether or not they deliver on their performance expectations, in terms of both return and diversification.