John Rekenthaler, Morningstar, on why liquid alternatives make sense.

Spawned after the 2008 financial crisis, liquid alternatives have disappointed investors. During the 2010s, these instruments averaged an annualized gain of 1.66%. Writing in Morningstar, columnist John Rekenthaler makes a telling comment in his article Liquid Alternatives Funds: Is There Any Hope?: “The concern lies when the hedged investment trails high-quality bonds, as has been the case with liquid alternatives funds. In that case, why bother with trickery? You could just hold Treasuries instead.” (Morningstar)

Nevertheless, Rekenthaler goes on to argue that the circumstances that so crimped liquid alternatives’ returns may be changing. Despite their drawbacks, investors should consider liquid alternatives for three reasons.

Equity valuations are at record levels

Rekenthaler points out that equity markets are at stratospheric levels and investors should, now more than ever, hedge their bets.

Liquid alternatives offer a hedging mechanism that may not be perfect.

“But at least their function is required,” argues the author.

Treasury yields have tumbled

From 2.5% yield in January 2009, 10-year Treasuries now offer 1.3%, while cash pays nothing. A liquid alternative fund may offer much better returns, with acceptable additional risk.

The fund “is also likely, over a full market cycle, to bring at least somewhat higher returns,” says Rekenthaler.

Liquid alternative funds have a history

From being a new and unknown investment vehicle a decade ago, liquid alternatives have come some distance: 46 funds are having 10-year track records. Now, investors can glean “some tentative conclusions” from these funds, and make more informed decisions says Rekenthaler.

He concludes the article by suggesting four liquid alternative funds that carry Morningstar’s second-highest Analyst Rating of Silver. “Selecting one or more of these funds would also make for a sensible hedge,” he writes.

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