Beachhead Capital Management has published a white paper on what it calls the “second generation of liquid alternatives.”
To begin at the beginning, “liquid alternatives” are investment products, available to retail investors, for example through mutual funds or ETFs, which are designed to provide the diversification and absolute-return benefits typically associated with hedge fund strategies. Liquid alts offer these strategies far beyond the bounds of the limited class of qualified investors who can avail themselves directly of the hedge funds.
The first generation came into existence in the wake of the global financial crisis. But growth in the field has slowed, the paper finds, as the promised diversification benefits – what one might fairly call the “hype,” – failed many of the investors naturally attracted to the idea. Also, the fees were too high for the market. The investors came to understand that they were paying sub-advisory fees and other expenses as well as the top-line fees.
The paper from Beachhead maintains that Generation Two products will address these issues.
One underlying institutional issue involves the mechanics of “filling a bucket.” If a cost-conscious investor has a fixed share of assets under allocation that it wishes to expose to the risks and returns of large-cap U.S. equities, it is said to have such a “bucket” to fill. Nothing is easier in that case: it can buy an ETF exposed to the S&P 500.
Filling the Hedge Fund Bucket
Now: suppose that it wants to fill up a hedge fund bucket. That’s tougher if it is an institution with pockets of only modest depth. A deep-pocketed institution can and will diversify across dozens of funds in order to try to get the diversification right, because as this white paper says “idiosyncratic manager risk is much, much higher” in hedge funds than in stocks or other traditional assets.
