Liquid alternatives are growing their share of the hedge fund market as investors see value in liquidity and transparency
Liquid alternatives are growing their share of the hedge fund market as investors see value in liquidity and transparency
Most alternative investments, such as private equity and hedge funds, have historically been offered as illiquid private placements sold to high-net-worth and institutional investors. Private placements require less disclosure than publicly traded products and have little to no regulations on leverage, derivatives, short selling, or concentrated positions.
The regulation governing open-end investment funds in Europe is the Undertakings for Collective Investments in Transferrable Securities (UCITS). UCITS regulations offer fund managers a ‘passport,’ meaning funds properly registered in one European domicile can be marketed across the EU. In contrast to the lighter regulation of private hedge funds, funds regulated by UCITS must follow a number of strict guidelines, such as a limit on the holdings of illiquid investments at 10% of assets under management (AUM) or leverage and risk typically limited to 200% of the underlying assets.
In recent years, growth in the liquid alternative investment market has eclipsed the growth of private alternative investments. The AUM of the global private hedge fund business recently passed $3tn, up from $1tn in 2005 and $2tn in 2011. AUM for alternative mutual funds (offered in the regulated world of UCITS in Europe and the Investment Company Act of 1940 in the US) recently reached $873bn, up from $156bn and $495bn in 2005 and 2011, respectively. Liquid alternatives, then, have grown from 13% of the global hedge fund industry in 2005 to 23% today. However, liquid alternative mutual funds still only control about 2% of the assets in the regulated open-end mutual fund market in the US and in Europe.
Investors are drawn to alternative mutual funds due to their greater liquidity, as redemptions may be daily or weekly while private hedge funds may offer quarterly redemptions subject to gates and lock-up periods. UCITS funds have greater disclosure than private hedge funds and much tighter controls on risk exposures. It is encouraging that managed futures mutual funds have a correlation of returns to managed futures hedge funds exceeding 80%, showing that liquid alternative funds have succeeded in bringing diversification and risk management to the retail market.
About the CAIA Association
The CAIA Association is a global professional body dedicated to creating greater alignment, transparency, and education for all investors, with a specific emphasis on alternative investments. A member-driven organization representing professionals in more than 95 countries, CAIA Association advocates for the highest ethical standards in the investment industry.
For more expert insights on the European alternatives market, read 2020 Preqin Markets in Focus: Alternative Assets in Europe.