Wednesday, May 28, 2014

Liquid-Alternative Investments

Liquid-Alternative Investments

In the past couple of weeks, the financial press has carried a number of stories on the amount of capital flowing in Liquid-Alternative Investments (LAIs).  For those of you who stick with plain-old stocks and bonds, liquid-alternatives are hedge fund-like strategies packaged in a mutual fund wrapper.  It’s an appealing name because it combines the daily liquidity of a mutual fund with the supposed sophistication of a hedge fund.  For fund distributors, money managers, and brokers, the recent proliferation of the LAIs is a welcome development.  Mutual fund investors have been slowly pushing down fees by reallocating assets into index funds and ETFs.  LAIs offer Wall Street a break in these trends.  Last year investors poured $40 billion into LAIs mainly through financial advisors at major wire houses.  The level of money flowing into LAIs doesn’t yet compare to the amount of money allocated to conventional investment categories, but LAIs are very profitable to Wall Street.

Interestingly, LAIs appear to be less expensive than many conventional hedge funds.  Rather than paying 2% and 20% plus fund expenses to a hedge fund, high net worth investors can pay 1.5% to 2.5% for LAIs without lock ups and other liquidity constraints.  From what I can tell, the performance isn’t much different.  Some LAIs have performed reasonably well, others have flopped, and most are very difficult to measure.  All that’s lacking is the cachet of being able to tell your friends that you employ a hedge fund manager.

While LAIs may be less expensive than hedge funds, they are nonetheless, expensive.  In addition, many of them have active trading strategies that cost investors a great deal although the expenses isn’t captured in the fee data.  I spent a few hours looking at the holdings of three of the largest LAIs (MainStay Marketfield  (MFLDX), Gateway  (GATEX), and Goldman Sachs Strategic Income  (GSZAX).  The first two funds are equity long-short strategies and the third fund is non-traditional bond fund.   There’s nothing particularly impressive about any of these offerings. 

Mainstay is slightly long the equity market with short positions created in large measure through ETFs.  As I looked at their holdings I kept wondering why I’d pay an active money manager to buy or sell ETFs on my behalf.  Moreover, I’m pretty sure an individual investor could create the same hedge with a few puts, by writing some calls, or holding a bit of cash. 

Gateway only charges 0.96%, but it’s a long-short fund that isn’t running any shorts.  In fact Gateway looks like a closet index fund that has wildly underperformed the S&P 500.  

Goldman is both leveraged and hedged with a net negative exposure to bonds.  Given the fund’s turnover and number of holdings, this fund is a goldmine for Wall Street traders.  Again, investors could replicate this fund at a fraction of the 0.99% that it charges.

Liquid-Alternative Investments are a fad that is working.  It’s just not working for investors.

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