The 2008 financial crisis accomplished in 12 months what I have been trying to do most of my 26-year career: educate investors about the benefits of allocating some of their portfolio to alternative investments, in particular, hedge funds and managed futures.
One of the great truisms of investing—"If you lose 50%, you need to make 100% just to get back to even"—goes a long way toward explaining why 2008 was so effective in stirring up interest in alternative investments. Even though hedge funds lost an average 19% that year, their performance was a lot better than S&P 500's 38% trip south. Some managers within popular hedge fund strategies, like global macro, actually made money. Managed futures turned in a glowing performance, up close to 16%.
The events of 2008 sharpened investors' understanding of the importance of liquid, non-correlated returns. In the process, it transformed the image of alternatives from shadowy, swing-for-the-fences vehicles for the one-percent into powerful risk management tools for conservative investors. Linking "conservative" and "alternatives" sounds as incongruous as "steak" and "vegan," but investors got the message that alternatives can play defense as well as offense. The new look of alternatives is a welcome and long-overdue change. (Endowments like Yale's and Harvard's were early adapters of alternatives and have invested billions, but they have advantages over individuals: They invest for the very long term and have full-time staffs to evaluate managers.)
I don't know if this search for double-digit returns, coupled with the new desire for non-correlated returns, will result in the assets of hedge funds (also called private funds) doubling in five years to $5.1 trillion, as Citigroup predicted in a June survey. What I do expect is that a much broader range of investors will gain access to this asset class through liquid alternatives.
Liquid alternatives give all investors access to a huge range of alternative strategies that were previously closed to them. Whether they use alternative mutual funds or alternative ETFs, both potentially offer investors the best of the traditional and alternative worlds. They blend alternatives' history of strong, risk-adjusted returns, opportunistic and flexible strategies, and lower volatility with the advantages of mutual funds and ETFs. Those pluses include daily liquidity, low investment minimums, transparency and relatively lower fees.
As the accompanying chart shows, assets in liquid alternative mutual funds took off after 2008. As of March 2012, they totaled $99 billion, a 138% increase since October 2008.
Alternative ETFs have attracted even more assets, about $144 billion by Morningstar's last count. My preference, not an unbiased one, is for liquid alternative mutual funds. Let me spell out the differences.
