In mutual funds and exchange-traded funds (ETFs), one of the biggest stories of 2014 will be the growth of “liquid alternatives.” Large asset managers are putting big budgets behind new fund launches and programs to expand advisor and investor education. Leading hedge fund managers are evaluating the merits of expanding by launching registered funds.
For all of 2013, Morningstar reported that alternative mutual funds captured $40.2 billion in net inflows and grew to $132 billion in total assets, representing a 43.9% organic growth rate (from inflows). In January of 2014, the torrid growth pace continued with $4.4 billion in inflows. Twice as much money has flowed into alternative mutual funds over the past year as into all U.S. taxable bond funds combined!
Idea #2: Focus first on the “big five” categories.
Of the 13 alternative categories tracked by Morningstar, five are mainstream. The table below shows these five ranked by assets and net inflows for 2013 and January of 2014. (Both mutual funds and ETFs are included.)
Idea #3: Decide where alternatives fit into your investment process.
Morningstar defines an alternative investment as one that aims to produce positive risk-adjusted returns over a reasonable time frame, with a relatively low correlation to traditional investments.
Idea #4: Look behind the labels.
Within each category, investment strategies and style can vary widely. For example:
Idea #5: Don’t lower your fund selection standards.
Since the liquid alternative space is so dynamic, it’s a good idea to be open-minded to new funds and unfamiliar managers, but it doesn’t mean you need to lower your tried-and-true selection standards. For example, suppose your method is to select mutual funds with: 1) manager tenure of at least five years; 2) expense ratios of not more than 1.50%; 3) Morningstar performance ratings of at least four stars; and 4) at least $100 million in assets under management. What liquid alternative choices do you have?