PIMCO Examines How Liquid Alternatives Fit into Portfolios

PIMCO Examines How Liquid Alts Fit into PortfoliosInvestors have poured nearly half-a-trillion dollars into liquid alternatives since the financial crisis, in pursuit of better risk-adjusted returns and diversification. The number of funds launched and assets under management (“AUM”) are both on the rise, with funds tripling since 2008 to more than 700 and AUM quintupling to $500 billion over that same time. Asset managers have been scrambling to offer alternative exposures to their clients, and PIMCO – best known for its bond funds – has become the largest manager of liquid alternative mutual funds in the U.S., according to Morningstar.

Liquid alts offer the potential for downside protection and attractive risk-adjusted returns, which make them particularly appealing amid the current environment, but implementing liquid alts within existing portfolios presents investors with a number of challenges. These challenges – and how to best address them – are the subject of PIMCO’s September 2015 In Depth white paper, Liquid Alternatives: Considerations for Portfolio Implementation.

Defining Liquid Alternatives

PIMCO defines liquid alts as any investments that “exhibit modest to low correlation with traditional stock and bond investments and are accessible in broadly available investment vehicles that are without the principal lock-ups of traditional private equity funds and hedge funds” – essentially, mutual funds and ETFs investing in alternative asset classes or pursuing alternative strategies.

Alternative asset classes include currencies, commodities, and real estate-linked assets. These are investments whose primary drivers of risks and returns are different from long stock or bond beta. PIMCO also includes “bear market” as a category within the alternative asset classes subset.

Alternative investment strategies include managed futures, equity market-neutral, long/short equity, nontraditional bond, and multi-alternative strategies. These are actively managed strategies that include a high degree of managerial discretion and a “broader toolkit” to enhance returns and/or diversify risk, according to PIMCO.

Regardless of whether they have an alternative asset class or alternative strategy focus, liquid alts differ from hedge fund and private equity investments in the following ways:

  • Liquid alts have lower investment minimums;
  • Liquid alts usually have daily liquidity;
  • Liquid alts have superior transparency; and
  • For U.S. investors, liquid alts have simplified tax reporting, relative to hedge funds and private equity.

Understanding Liquid Alts

Liquid alts have risk/return characteristics that differentiate them from traditional stock and bond strategies, but also from one another. Long/short equity managers, for example, typically have positive equity beta; equity market neutral does not, and managed futures may use leverage to have an equity beta of greater than 1 or less than 0. One size definitely does not fit all when it comes to alts – this is part of their beauty, but it also complicates things. With this in mind, PIMCO says investors should have a “solid grasp” of the following before adding liquid alts to their portfolios:

  • The investment’s total volatility and mix of risk, particularly correlations to traditional portfolio risks (i.e., equity risk and interest-rate risk);
  • Its historical drawdowns and drawdown potential;
  • Its level and use of risk, including options; and
  • The investment’s historical performance during different stages of the market cycle.

Implementing Liquid Alts

In selecting a liquid alts manager, PIMCO says investors should look for managers with the following attributes:

  • Exceptional and proven manager experience (i.e., consistent and strong returns across market environments);
  • A well-defined and repeatable investment process;
  • Depth of research and a demonstrated ability to put that research to productive use;
  • Trading efficiency;
  • Robust risk management;
  • Ability to clearly communicate strategies; and
  • Regulatory compliance and experience in the mutual fund/ ETF industry.

Liquid alts can be implemented as a dedicated slice of an existing strategy, or as a core complement. PIMCO advises investors to proceed with caution, but to proceed nonetheless – “Amid an environment of lower yields, higher valuations, and slower global growth, liquid alternatives can be an important addition to investor portfolios,” the paper’s authors write. But investors “should be aware of several key considerations before investing.”

For more information, download a pdf copy of the white paper.


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