By Chris L. Meacham, CPA,

Since the 2008 financial crisis, investors and advisors have been looking for ways to mitigate risk by emphasizing downside protection and diversifying their portfolios with non-correlated assets. One of the results is the recent increase in funds called liquid alternatives or “liquid alts.”  Historically, alternative investments—also known as nontraditional, private investments, or private placements—tend to be illiquid.  By packaging alternative investments in mutual funds or exchange traded funds, fund managers of these investments are able to offer increased liquidity.  Liquid alts, which were once the domain of high-net-worth investors, have nearly tripled since 2008.

Liquid alts are intended to stabilize portfolios because they, according to Shelly K. Schwartz of CNBC.com, “Zig while the traditional stock and bond markets zag.” In addition to their promise to mitigate risk, liquid alts are entering the mainstream because they have no income requirements and can be bought and sold daily through the stock exchange—making them accessible to the average investor. They are also attractive to the high-net-worth individual whose lifestyle requires access to liquid capital.

However, although there can certainly be benefits to adding liquid alts to your portfolio, here are some things you should consider:

There are costs involved in substituting direct private placements with liquid alts.

Liquid alts use complex strategies such as long/short equity, managed futures, market neutral, multi-alternative, multicurrency and nontraditional bonds. Due to this complexity, liquid alternatives require active management, frequently resulting in higher fees than traditional funds.

Because of the complex strategies applied by liquid alts, it can be difficult to understand these investments and the associated risks.

Liquid alts are limited in the range of investment strategies they can pursue because they are constrained by having to meet their daily liquidity requirements. Private placements, on the other hand, have many more investment opportunities available.  Although liquid alts attempt to mimic private placements, they may not always be successful.

Short Track Record:

Today, there are over 400 liquid alternatives available, but many of them are less than five years old. Therefore, they haven’t really had time to be tested. As David Lafferty, senior vice president and investment strategist at Natixis Global Asset Management said, “These funds are going to have to live up to the diversification, performance and risk promises to stay top of mind with investors.”

Like all investment strategies, liquid alts have their pros and cons. It’s great that they are becoming more accessible to the general public and are designed to mitigate risk; however, because of their complex nature and relatively new emergence in the mainstream, it’s a good idea to consult a professional to discuss your options. Here at Cornerstone, after carefully considering our clients’ objectives, we tend to use both private vehicles and liquid alts in addition to traditional investments to properly diversify portfolios.