“They’re a set of products that are liquid, can be offered daily, and can play a role as a diversifier,” Dhanani says. “They’re going to be more correlated to your equity in certain markets. But that doesn’t mean they can’t be a good diversifier, especially in rising or stable interest rate environments. I’m now seeing this shift into liquid alts, particularly long-short credit funds which exhibit a lower chance of permanent loss of capital than many private assets.”
Part of that shift, Dhanani says, has to do with perception. Many financial advisors have marketed themselves on allocating to private assets and alternatives to mirror how pension funds and institutions invest. The issue is that retail investors don’t have the assets, time horizons, or liquidity requirements of a pension or an institution.
There’s also a move away from balanced funds, in part because of the losses these strategies experienced in 2022, and in part because of the apparent lack of sophistication in using a one-stop-shop strategy. Dhanani sees a move among advisors to show more line items, which can also more effectively display how different parts of the portfolio are performing — rather than a single line showing positive or negative performance. In this new more nuanced picture advisors are drawing for their clients, Dhanani sees ‘liquid alternative funds playing a key role.
These mutual funds allow retail investors to go long, short, or use leverage. In the case of corporate bonds, these strategic overlays allow investors to control for interest rate risk and credit spreads. Investors can more tactically decide where, when, and how they want to take exposure to a corporate bond. This strategy proved its value in 2022.
When bonds and equities moved with positive correlation, few deviated from their fixed income strategies, paying lip service to their time horizons and long held adages about portfolio construction. These funds, however, were able to short government bonds and long corporate bonds to hedge out much of the interest rate risk in a fixed income portfolio. The result was very stable performance in a year when stability was hard to come by.
