Liquid alternatives: a worthwhile trade-off?
Liquid alternative products, a fast-growing asset class globally, are increasingly being touted in Asia, but some see them having the potential to harm the reputation of the industry.
Liquid alternatives are typically hedge fund, private equity, real estate and infrastructure investments offered in structures that comply with the US’s 40 Act or Europe’s Ucits requirements. Hence they have tighter conditions around how they are managed than typical alternative funds.
Numerous firms are promoting such strategies in Asia, including Swiss alternatives manager Gottex, France’s Natixis Global Asset Management, US fund-of-hedge-funds firm Arden Asset Management and K2 Advisors, a fund-of-funds business owned by Franklin Templeton Investments.
K2 launched a Ucits version of the Franklin K2 Alternative Strategies Fund in September with daily liquidity. Meanwhile, JP Morgan Asset Management and FoHF manager Permal are planning to bring Ucits-compliant FoHF products to the region. Permal is aiming to do so in the first quarter next year, while JP Morgan AM declined to give a time frame.
So far this year, Ucits hedge fund products have performed worse than hedge funds as a whole. In the year to end-October, Preqin’s Ucits hedge fund index is up 1.23% year-on-year compared to a 2.92% rise for hedge funds overall.
Still, there is interest from the likes of private banks in Asia, as they look to add more alternatives to their wealth management platforms.
Bank of Singapore, the private banking arm of OCBC, is looking to increase its minimal exposure to hedge funds, as reported. Ucits-compliant strategies are an area of focus, with the firm citing their relatively higher levels of liquidity and disclosure.
Edmund Yun, Hong Kong-based executive director for investment at RBC Wealth Management, noted: “It’s difficult to find very liquid alternatives, ones that allow investors to liquidate within a week and consistently deliver good performance.”
Meanwhile, Michael Levin, head of alternatives for Asia Pacific at Credit Suisse Private Banking, of Credit Suisse, suggested it was only a matter of time before Asian clients showed more substantial demand for liquid alternatives.
However, sceptics see the push in liquid alternatives as a rush to attract investors before the potentially inferior performance of these products is exposed.
Liquidity constraints on such funds may result in managers having to sell assets under conditions that negatively impact strategies being run by the same managers but without the same constraints. Inferior performance is inevitable as a result, argued David Walter, Asia head of research at Pacific Alternative Asset Management Company, a FoHF firm.
The constraints on 40 Act and Ucits-type hedge funds – which can include limits on shorting, leverage and use of certain derivatives – mean they cannot deliver returns as good as hedge funds that are only slightly less liquid, he said. Hence Walter believes it’s a bad trade-off.
Private bankers who had pulled out of hedge funds post-2008 are now offering these new products, “shoving their clients into something that’s got slightly less downside – because of the liquidity – but a significantly worse risk-return profile”, added Walter.
Others make similar points. “Different liquidity metrics can create tension and disadvantage certain investors on the mark-to-market,” agreed Asaf Berman, Singapore CEO of Swiss multi-family office Nutrimenta. “The only reason these things are being offered is to raise capital from less sophisticated clients.”
The liquid alternatives asset class is the fastest growing part of the investment industry globally, according to a Deutsche Bank survey released in September.
Liquid alternative assets under management have recorded a 40% compound annual growth rate (CAGR) since 2008 to stand at $600 billion as of mid-2014, said the report. That far outstripped the 13% CAGR for hedge funds, 9% for US mutual funds and 2% for European Ucits products over the same period, though admittedly from a much lower base.
But Asian investors have been slow to embrace these funds. The region accounts for only 2.7% of alternative Ucits investments worldwide, according to data provider Preqin. This proportion has remained flat – highlighting growth that is neither faster nor slower than the global average.
As with any nascent asset class, the proof will be in the eating. If investors in Asia feel the performance of liquid alternatives justifies the fee premium over traditional mutual funds, no doubt the flows will come.
*A full feature on liquid alternatives appeared in the latest (November) issue of AsianInvestor magazine.