Is the Liquid Alternatives Industry in Decline?

by Boris Friedman

  • 01 Jun 2018
  • HF

Following the Global Financial Crisis, alternative mutual funds and alternative UCITS experienced increased demand from investors; however, interest for liquid alternatives may now be dwindling. According to the 2018 Preqin Global Hedge Fund Report, 16% of investors planned to include liquid alternatives in their 2018 mandate searches, a four-percentage-point decrease from 2017.

The decreased investor interest in liquid alternatives is likely due to lackluster performance in comparison to the hedge fund universe as a whole. On a five-year annualized basis the Preqin All-Strategies UCITS benchmark and the Preqin All-Strategies Alternative Mutual Fund benchmark returned 3.09% and 3.28%, respectively, while the broader Preqin All-Strategies Hedge Fund benchmark has generated over twice the five-year annualized return at 6.98%.

It is to be expected that liquid alternatives might underperform more traditional hedge funds due to the regulatory restrictions imposed on them on an absolute basis, but investors do look towards these vehicles to generate risk-adjusted returns. However, the average Sharpe ratio of liquid alternatives is lower than the broader hedge fund industry. The five-year Sharpe ratio of UCITS is 0.32 with alternative mutual funds attaining a similar ratio of 0.34. The broader Preqin All-Strategies Hedge Fund benchmark has achieved a more favorable Sharpe ratio of 1.32 over the same time.

Preqin’s online platform currently tracks 1,528 active liquid alternative vehicles, accounting for 10% of the overall hedge fund industry. The alternative mutual fund industry has been shrinking following a promising period of growth between 2011 and 2015. After its peak in 2015, with 526 active funds, the number of alternative mutual funds has decreased by nearly 16% to 439 as at June 2018.

An especially tumultuous year, 2016 is the first instance of alternative mutual fund liquidations outpacing launches. A likely reason for the decrease in alternative mutual funds is due to the decrease of launches by North America-based managers. After launching 62 alternative mutual funds in 2015, North America-based launches decreased by a staggering 85%, to only nine in 2016. Meanwhile, North America-based UCITS launches leveled off on a smaller scale, suggesting that North America-based managers may have shifted their preferences to launching UCITS vehicles in Europe.

UCITS have fared better but are also showing signs of slowing growth in 2018. In 2014 and 2015 UCITS had record launch figures of 143 and 159 funds respectively; however, over the same time period, a more substantial proportional increase in liquidations occurred. Furthermore, 2016 saw the first decline in the number of UCITS launching compared to previous years, with the downtrend continuing into 2017. As a result, the growth of active UCITS funds has plateaued over the past few years.

Liquid alternatives will continue to face a challenging environment for the foreseeable future. With the wider hedge fund industry producing comparatively superior returns, alongside a downward trend in investor allocation plans towards liquid alternatives. Alternative mutual funds look set to take the brunt of the decreased interest as UCITS have become the preferred vehicle for North America-based fund managers.

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