Economic conditions may be shaping for a portfolio allocation to liquid alts.

As bonds failed to provide protection in 2022, investors have turned to liquid alternatives (hereafter referred as Liquid Alts), which offer exposure to asset classes or investment strategies that are considered alternative to traditional assets with similar liquidity profiles. Examples include hedge funds, commodities, and REITs.

Understanding what liquid alts are is key, but classification may not be simple as they employ different strategies and may invest in different assets. A useful classification of the use of alternatives in portfolios distinguishes among modifiers, diversifiers, and opportunistic strategies, which may improve outcomes on a risk-adjusted basis. (Portfolio Adviser)

How have these investments performed?

Historically, during recessions, global macro and managed futures hedge funds have performed better than other hedge fund categories, including equity market neutral and event driven, and this is consistent with their primary goal of providing portfolio diversification. During the tech bubble burst in 2001, hedge funds delivered better returns than equities, with managed futures and global macro playing the role of best performers.

However, commodities and REITs have not performed well during recessionary environments.

Points to consider for investing in liquid alts

Investors should understand the strategy and asset class, set realistic expectations, understand the role of liquid alts in the portfolio, and pay attention to costs. Proper due diligence is needed, and investors should not fully rely on classifications.

A multi-asset portfolio with different strategies may improve outcomes on a risk-adjusted basis that cannot be achieved by the sole use of traditional asset classes.

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