What Exactly Are Liquid Alternatives?

Apr 09, 2019 | Jonathan Yung


Many Canadian investors are unfamiliar with the term “liquid alternatives” and its meaning. Or perhaps you’ve heard the term, and want to learn more.

The term “liquid alternatives,” or “liquid alts,” refers to a new category of investment, which has opened up opportunities for investors to evolve partially away from traditional investment portfolios. Recently, volatile equity markets and low fixed-income yields have led investors to take on increased risk.  New regulations that were introduced in January allow individuals to access non-traditional strategies, which are commonly utilized by institutional investors like CPP, and can help lower risk.

Liquid alternatives typically invest in non-traditional asset classes, and/or utilize alternative strategies that were once exclusively used by hedge funds and institutional investors. They may offer the opportunity for improved returns across a range of economic and market environments, while providing new ways to manage risk. Their aim is to provide investors with diversification, with fewer correlated asset classes.

“Alternative asset classes” include examples like infrastructure, real estate, commodities, private equity, currencies and non-traditional fixed income, such as structured credit.

“Alternative strategies” include examples such as short-selling, leveraging, and derivatives. These strategies are commonly used by institutions and accredited investors, as ways to protect the investment on an ongoing basis. There is a myth that short-selling, leveraging and deploying derivatives are associated with riskier strategies used by hedge funds; however if these strategies are used appropriately, they can protect the investment during highly unstable periods such as 2008 and 2018.

(Source: Russell Investments Canada Limited)

It has taken five years for the Canadian regulatory bodies to develop and finalize rules and procedures for this asset class, which some on Bay Street are calling “the next market disrupter.” On October 4th 2018, the Canadian Securities Administrators released a finalized set of rules, designed to allow retail mutual funds to use alternative strategies like leverage and short-selling. The following new rules came into effect on Jan. 3, 2019.

(Source: RBC Dominion Securities)

Liquid alternatives have seen enormous growth in the United States and Europe, where they have been available for many years. A July 2015 survey by Barrons and Morningstar in the US found that over 60% of advisors planned to allocate more than 10% of their portfolios to liquid alternatives within the next 5 years. Currently, there are over $200 billion in assets that are invested in liquid alternatives in the US and over $400 billion in Europe.

It will likely take years for Canadian investors to fully adopt this new category of investment. Some fund companies, such as Mackenzie and Dynamic, had a jump start in early 2018, when they were granted exemptions to introduce new liquid alt funds at that time. Although they have not yet reached the one-year mark, we will keep a close eye on their performance as data becomes available.

There are definite merits in liquid alternatives, but, more importantly, we as investors now have more options available to us. Please contact your advisor if you’d like to discuss whether incorporating liquid alternatives into you portfolio might align with your investment goals.