Record-low interest rates and historically high stock valuations have more and more investors considering liquid alternative investments, which Goldman Sachs Asset Management (“GSAM”) defines as “daily liquid investment strategies” that seek to deliver “differentiated returns from those of core assets” and the potential to mitigate overall portfolio risk and severe drawdowns. In a recent Strategic Advisory Solutions white paper, GSAM makes the case for a multimanager approach to liquid alternative investing – through single turnkey multimanager funds, allocations across multiple managers of the investor’s choosing, or a combination of both.
Why Diversify an Alternatives Allocation?
GSAM categorizes the liquid alts universe into five peer groups:
- Equity long/short
- Event driven
- Relative value
- Tactical trade/macro
As shown in the table below, the median returns of each peer group have very little persistence from year to year. Therefore, by diversifying across peer groups, investors can avoid the highs and lows of any given year in any given strategy.
Building from Scratch
One approach to diversifying across liquid alternative peer groups is to “weave” several liquid alts into a “unified portfolio construction framework.” This approach may be best for investors seeking to express high-conviction market views of their own, or for those who possess deep knowledge of particular strategies and managers.
But in GSAM’s view, the process of selecting liquid alts requires expertise in the asset class, knowledge of manager capabilities, and judgment of manager and strategy risks, among other things. This makes the “build” approach research-intensive, which may be a bit much for many investors.
On the opposite end of the spectrum is the “turnkey” approach – a pre-assembled package of alts, such as a multimanager alternative mutual fund. In this approach, investors effectively outsource the research-intensive process cited above to professional managers. On the downside, investors employing this approach don’t get a customized allocation, which means that their specific investment needs could potentially be better-served.
What are some other risks to the multialternative approach? GSAM lists several, including:
- Performance may depend on the ability of the investment advisor to select, oversee, and allocate funds to individual managers, whose styles may not always be complementary.
- Managers may underperform the market generally or underperform other investment managers that could have been selected instead.
- Some managers have little experience managing liquid alternative funds, which differ from private investment funds.
Investors should be mindful of these and other risks, according to GSAM.
The Best of Both Worlds?
GSAM calls combining the “build from scratch” and “turkey” approaches “Buy & Build.” This hybrid approach generally entails complementing a multialternative fund with one or more high-conviction managers the investor believes can potentially contribute to specific investment objectives. This “middle ground” between pure customization and an off-the-shelf solution gives investors additional flexibility with a fraction of the research-intensity.
In conclusion, GSAM states the company’s belief that multimanager strategies have the potential to help investors pursue additional sources of returns and to diversify their alternative investment allocations. In the firm’s view, investors who are new to investing generally opt for the single package approach to multimanager investing, while more experienced liquid alternative investors often consider building from scratch. The important thing, in GSAM’s estimation, is to understand the potential that liquid alts offer as an additional driver of portfolio returns.
For more information, download a pdf copy of the white paper.
Jason Seagraves contributed to this article.