Liquid vs 'real' alternatives in COVID-19 era

Advisor and advocate disagree on whether liquid alts have proved their value or require closer analysis

Liquid vs 'real' alternatives in COVID-19 era

The COVID-19 downturn has been the first major test of an asset class that promised strong performance in down markets: liquid alts.

One leading alternative investment advocate believes that, broadly, liquid alternative funds have performed as expected, employing “lite” versions of hedge fund strategies like short selling and leverage to outperform equity markets. One leading advisor, who uses “real” hedge fund alternative strategies to serve a client base of accredited investors, hasn’t been totally convinced, however, and thinks that if an investor can’t invest with a hedge fund, they should employ caution and do their due diligence when looking for liquid alts.

“We're incredibly pleased at how [liquid alts] have stood the test through this volatile period in Q1 and March in particular, vastly outperforming their long only index peers and benchmarks,” said Claire Van Wyk-Allan, director of the Alternative Investment Management Association (AIMA).

“We always look at the Scotiabank alternative mutual fund index. For the month of March, it drew down 6.61 per cent versus the SMP TSX composite, which was down 17.74 per cent.”

Van Wyk-Allan believes that criticisms of the asset class as a thought-project of the bull market that couldn’t handle a downturn are being disproven with every day of outperformance.

She noted, though, that it’s crucial for these funds to operate within necessary liquidity parameters, especially in a downmarket. She’s pleased by the quality of management displayed during this downmarket as portfolio managers have maintained appropriate cash reserves to meet redemption requests.

Arthur Salzer isn’t sold. The CEO and CIO of Northland Wealth Management has been a long-time advocate of alternative investing but notes that both “real” and liquid alts require significant due diligence and research legwork on the part of investors and advisors.

“It’s nice that [liquid alts] are there, it’s good to have more choices, but it takes a lot of due diligence to understand what makes these funds tick,” Salzer told WP. “I’m not sure how somebody who’d be buying a hedge fund strategy on the public market would know how to do three to six months of due diligence to go through the underlying mechanics.

“It’s good that they’re available, and there are some really good ones and some really mediocre ones but it takes a lot of work. We’ve got six CFAs on staff to do that due diligence.”

He thinks that investors and advisors who can’t do the due diligence to sort out which liquid alt funds work for them should look to other asset allocation strategies that offer lower fees.

Despite his trepidation around liquid alts, Salzer’s “real” alts strategy has largely paid off for his investors in the downturn. He employs what he calls a “new 60-40” where 40 per cent of the portfolio is made up of private alternative investments. At the lowest point, when markets were drawn down around 30 per cent, his office hit a nadir of -10%. Most of his families, now, sit only a little bit below where they were at the start of 2020.

Van Wyk-Allan maintains that liquid alt funds should be an “evergreen” part of any investor’s portfolio. Despite the downturn, she thinks now is a good time to invest in the asset class, building an allocation with greater diversification than the traditional 60-40 split. She thinks advisors should do their due diligence when selecting an alt fund, though, looking at the fund’s liquidity parameters and the manager’s track record. Advisors need to match the right funds to the right investor.

“The managers that we are speaking to are seeing a plethora of opportunities in the market, and they're certainly very risk minded and so ensuring that they are taking advantage of opportunities, while still taking the utmost caution to protect portfolios on the downside,” Van Wyk-Allan said. “Canada has incredible talent on the manager side in alts.”