One of the hottest investment trends of the past few years has been liquid alternative exchange-traded funds, also known as liquid alts or liquid alt ETFs. Investment strategies involving these specialized funds have enjoyed significant growth in popularity, although some argue that the prices charged by money managers are too high.
First, let’s take a deeper look at what liquid alts are and what they’re made of, then we’ll look at the average fees charged to investors compared to their expected return on investment and see whether the fees are too low, too high, or just right.
Benefits of Liquid Alts
The name “liquid alts” derives from the fact that they offer consumers an alternative to traditional ETFs that are focused on a single sector. They combine investment strategies like real estate and private equity with the daily liquidity value offered by mutual funds, allowing smaller investors the power to trade the way major hedge funds do.
Additionally, by diversifying investments, consumers are protected from a downturn in one or more specific areas of the market. For example, if the AI and other tech sectors were to take a massive hit (which is unlikely in the foreseeable future, of course, but the point is that recessions can happen unexpectedly), it would likely signal massive losses across all traditional investment markets, as these are currently among the top performing industries.
This would be devastating for investors with long positions in most companies or funds listed on popular exchanges. With liquid alts, however, those losses would be significantly lower and the fund itself could potentially still turn a profit. In 2022, for example, the bond market suffered one of its worst years on record, losing a total of 12.6%. Conversely, liquid alt funds only lost 2.74% during that same period.
While this is still a loss and not the ideal outcome, it’s still nearly 10% less of a loss than was suffered by bonds, which have long been considered to be a solid, low-risk investment strategy.
Average Prices for Liquid Alts
One of the primary criticisms leveled against liquid alts is that the fees charged by money managers to invest in these funds are too high. Is this true or simply a disinformation campaign pushed by opponents of the system or holders of other types of ETFs? Let’s take a look at the data and decide whether the fees are reasonable or not.
According to industry experts, the average fee charged to small investors for liquid alts is approximately 3.0%. Conversely, the alpha or return on investment over the market itself is also generally around 3%.
This means that despite the stated aim of protecting clients’ investments from a single or multi-sector downturn, these funds generally provide little to no value for these clients, as their fees are equal to or greater than their rate of return. Any profit realized on the investor’s liquid alt investments goes straight to the money manager if they do not exceed the 3% hurdle above the market itself.
Are Liquid Alts Still a Good Investment?
Despite the high fees charged by some money managers as discussed above, liquid alts themselves are still a solid investment. One of the biggest deciding factors is the fee charged – as noted above, the average fee is 3%.
This means that investing with a money manager who charges less than 3% for liquid alts could be a solid investment strategy and choosing a manager who charges more than 3% may not be a wise allocation of the client’s resources, as all expected profits may end up going to the money manager instead of the investor. There are of course money managers that produce more alpha than 3% so for those the fee is justified and isn’t too high. The key is to factor in the manager’s fee and performance together in order to get a more holistic view as to whether or not their fee is warranted.
How Can I Choose Which Money Manager to Use?
Choosing a money manager for a liquid alt investment can be a difficult proposition, as it isn’t always easy to ascertain what the expected alpha will be for a given portfolio.
Money managers in general don’t like to share their particular investment strategies, even with potential clients. It’s regarded as a bit of a trade secret and specific details are held pretty close to the vest. This essentially means that predicting the performance of their holdings as a viable strategy becomes extremely difficult, but you can still use historical data to get a rough estimate on what you should expect.
However, as we do know that the average alpha for liquid alts can be assumed to be roughly 3%, the easiest course of action for choosing a money manager for these investments is to check their fee structure. If it’s 3% or higher, the manager will need to either (1) provide the historical performance data proving that they can and have exceeded the market by 3%, or (2) be willing to provide enough details about their strategy so that one can feel comfortable enough with future expected returns.
Conclusion and Final Thoughts
Liquid alts are a viable alternative for investors based on their historical performance. However, many money managers charge exorbitant fees that can essentially wipe out all profit margins for their clients so a careful examination of fees relative to alpha is essential.
Typically, money managers with better results tend to charge more for their services which is fine so long as the increased fees are justified by the alpha that the manager brings to the table.
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