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Big Picture

Liquid Alternative Funds: A Challenging Landscape

Our study shows the opportunities and limitations of the European liquid alt sector

Open-ended alternative funds, or liquid alts, are one of the European cross-border market’s biggest growth stories of the last decade: Liquid funds using hedge fund-type strategies generated tenfold asset growth in that time. But our recent study shows that this rapid growth hasn’t yet given way to maturity.

While U.S.-domiciled liquid alternative funds in mutual fund format saw their assets peak in 2014, European-domiciled liquid alts continued to see asset inflows through August 2018. Ultimately, the European alternative sector also began to lose assets during the volatile second half of the year.

One reason for investors’ attraction to alternative funds was the historically low interest rates in Europe, which discouraged investments in traditionally safe assets (like government bonds) and pushed investors to seek out alternative ways to create returns in the midst of limited volatility. However, the markets’ turbulence in late 2018 led investors to focus less on the effect of yields and more on identifying ways to reduce risk.

See our analysis of the landscape below.

3 learnings about the transformation of the European liquid alts landscape

  1. The liquid alts sector is experiencing rampant fund-lineup turnover. This is one of the top indicators of this specific industry’s immaturity. Between 2009 and 2018, this sector saw the introduction of more than 3,200 funds. But by the end of 2018, Morningstar data was tracking approximately 2,600 liquid alternative funds—indicating that a large amount of funds merged or liquidated. This movement can be attributed to asset managers introducing strategies in hopes of enticing investors to explore the alt-funds space, or to open onshore, UCITS-compliant funds that mirror existing offshore strategies. This fast lineup churn makes the asset class difficult to navigate for investors, as many of the sector’s funds are small, young, untested, and may not have ample resources behind them. These funds have been frequently launched as trial balloons, rather than being given the resources to grow into long-lasting franchises.
  2. Many young funds were unprepared to weather difficult markets. 2018 was the first big test for many of these nascent funds, which had not yet had to face difficult markets, and the majority failed it: A staggering 83% of funds in our alternative database saw losses, and the outflows continued through January and February 2019. Last year was particularly difficult, since most markets were down and diversification offered limited benefits; nonetheless, this period revealed some of the limitations on liquid alts’ value as diversifiers.
  3. The industry needs to be more up front about the abilities of these funds and their exposures to different risky scenarios. Alternative strategies don’t work in all market conditions and may need time to reach their targeted returns. Though the landscape remains tricky to navigate for investors, 2018 should serve as an effective reminder of the importance of using a fundamentally focused mindset to drive fund-selection decisions.
For the full analysis of the European liquid alternative funds landscape, download our white paper.
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