Liquid Alt Juggernauts: Worth their Salt?

Nope.

June 2021. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Liquid alternative mutual funds only captured 10% of the market share from hedge funds
  • The alpha generated since 2013 was essentially zero
  • Long-short equity funds can be replicated simply via market beta + cash

INTRODUCTION

One of the most perplexing questions in the investment industry is why liquid alternatives have not been able to disrupt the hedge fund industry in the same way as ETFs have captured significant market share from mutual funds.

Neither hedge funds nor mutual funds have created much value as measured by their alpha generation in recent years, which is primarily explained by high fees eating away any excess returns generated by the fund managers. Liquid alternatives tend to feature lower management and zero performance fees, which should be a more attractive value proposition for investors seeking alternatives.

In addition, hedge funds represent unregulated vehicles that require plenty of costly initial due diligence and ongoing monitoring, compared to liquid alternative mutual funds that are traded on regulated US exchanges.

Despite all these good arguments, the total assets under management in liquid alternative mutual funds were approximately $400 billion in the US in 2020, which is just barely more than 10% of the assets of the $3.6 trillion hedge fund industry. Why has the disruption failed? (read Liquid Alternatives: Alternative Enough?)

In order to evaluate the lack of interest in liquid alternative mutual funds, we will analyze the ten largest ones in the US.

FEES

We select the ten largest liquid alternative mutual funds in the US that focus on equities, which includes long-short, market neutral, event-driven, merger arbitrage, and similar strategies. These ten funds manage a cumulative $40 billion of assets, so approximately 10% of the entire assets under management of the liquid alternative space.

Although liquid alternative mutual funds aim to disrupt the hedge fund industry by offering lower fees, they are not particularly cheap. The average fee across these ten funds is 1.6%, which equates to an annual fee income of $