One challenge for liquid alternatives as an investment category is the lack of suitable benchmarks to gauge their performance. For the same reason that a bond benchmark is not appropriate for measuring the performance of stocks, and vice-versa, traditional benchmarks for the equity and fixed income markets, such as the Wilshire 5000 Index or the Barclays Aggregate Bond Index, are not appropriate for measuring the performance of liquid alternatives. The whole point of liquid alternatives is that they are trying to be different from stocks and bonds.
Fortunately, Wilshire Associates, a leading global investment consulting firm and creator of the Wilshire 5000 Index, among many others, has stepped up with a pair of indices designed to address this challenge: The Wilshire Liquid Alternative Index and the Wilshire Focused Liquid Alternative Index.
An Appropriate Measurement Tool
Liquid alternatives are specifically designed to have low correlations to existing broad-market benchmarks. And, while liquid alternatives employ “alternative strategies” similar to those of hedge funds, judging them by hedge-fund benchmarks isn’t entirely accurate either. Hedge funds have different liquidity provisions, and as a result can invest in a much wider range of assets, including less liquid securities that are not available to alternative mutual funds or ETFs. Hedge funds also have access to much greater leverage than mutual funds and ETFs, which further testifies to the need for liquid alternatives to have their own indices.
Industry veterans agree. Brad Alford, chief investment officer of Alpha Capital Management and portfolio manager of two liquid alternative mutual funds, said, “This is a great move forward for the industry. Financial advisors and other investors finally have an appropriate benchmark to use that is an ‘apples-to-apples’ comparison for their investments.” Alford went on to note, “The indices will also help advisors explain liquid alternatives to their clients and set realistic expectations for when and how they will perform in different market environments.”
Jason Schwarz, president of Wilshire Funds Management, says he and his firm have “seen first hand the surge in demand for diversifying liquid alternative strategies among the clients we advise.” Wilshire estimates that the number of liquid alternative products has increased nearly 500%, from 75 at the end of 2008 to roughly 450 as of June 2014. Schwartz says he believes the Wilshire Liquid Alternative Index will be a powerful tool to help investors understand how these difficult-to-track mutual fund strategies are actually performing.”
The new indices are cleary a step toward the institutionalization of the liquid alts market, if its not already there now, and potentially leads to a greater array of products based on the indices. Ben Deschaine, Head of Liquid Alternatives for Balter Liquid Alternatives, said, “Wilshire’s decision to produce an index that tracks the performance of the liquid alternative mutual fund space further legitimizes the growth of this innovative area of asset management.”
Wilshire Liquid Alternative Index Details
The Wilshire Liquid Alternative Index is designed to provide “a precise, broad market measure” for the performance of liquid-alts mutual funds and includes funds from five categories as shown in the chart below. Categories and funds are asset weighted with caps on total category weights and fund weights. Constituents must have at least six months of performance history, and must be alternative ’40 Act mutual funds. As of June 30, 2014, the Wilshire Liquid Alternative Index consisted of 351 components with $339.15 billion in total assets under management.
Wilshire Focused Liquid Alternative Index Details
The Wilshire Focused Liquid Alternative Index is “an optimized subset” of the Wilshire Liquid Alternative Index designed to provide a more risk optimized index. Wilshire uses proprietary research methodology and intelligent screening criteria to select the constituents, which must have at least $50 million in assets under management, and operating histories of at least 18 months. Each of the four strategy based categories are risk weighted, and within each category, funds are equally weighted. As of June 30, the index consisted of just 93 components.
Following the firm’s hedge fund classification system, Wilshire classifies alternative mutual funds into equity hedge, event driven, global macro, relative value, or multi-strategy. The Liquid Alternative Index’s methodology combines these strategy groups to ensure diversification, while the Focused Index excludes all but equity hedge, global macro, event driven, or relative value funds.; and takes the further step of rejecting any funds that are too highly correlated to long-only equities or fixed income. Both indices have a variable number of components, and both will be reviewed semiannually for potential changes to the indices.