Funds copying hedge-fund strategies to make money are on track to record their best ever net inflows this year as investors look for ways to escape volatile markets.
These funds, known in the asset management industry as liquid alternatives, charge lower fees than hedge funds, allow investors to take out money on a daily or weekly basis, and provide better transparency on how exactly they make money. As a result, both retail investors and institutions have poured money in the funds, especially in Europe, helping them grow faster than the hedge-fund industry.
Investors’ interest is fueled by fears that their traditional stock-and-bond portfolios won’t be able to absorb shocks from market turbulence as the U.S. Federal Reserve prepares to increase interest rates for the first time in almost a decade on Dec. 16 and stock market valuations hover near record highs. Capital flows are stronger in Europe, where investors are also trying to shield their assets from negative interest rates.
"Investors are moving into liquid alternative funds because they want to insulate their portfolios from market swings and be able to take money out if anything goes wrong," said Peter Laurelli, global head of research at industry tracker eVestment.
The open-end funds, typically designed to provide protection during a market decline, can short sell a security to make money in a falling market and borrow money to increase their bets like a hedge fund. Retail investors can, through a broker or private bank, invest $1,000 or even less. Hedge funds typically require a minimum initial investment of $1 million.
Liquid alternative funds received about $110 billion in the first 10 months of the year, 14 percent more than in the whole of 2014 and exceeding the previous record of $106.6 billion in 2013, according to data compiled by research firm Morningstar Inc. Total assets under management have increased by a 10th to about $715 billion this year after stock-market turmoil in China hit values, the data show. By comparison, assets managed by hedge funds increased by 1 percent to $2.9 trillion in the first nine months of the year, according to data from Hedge Fund Research.
About seven in every 10 dollars invested in liquid alternative funds this year has gone to European funds, boosting assets to 344.5 billion euros.
"The advent of not only low- and zero-interest rates, but now negative interest rates from the ’safer’ Northern European economies are drivers of the increase in interest among European investors," said Jeremy Beckwith, the director of manager research for Morningstar U.K. "The flows in Europe took off in 2014 as the ECB adopted first quantitative easing and later negative rates."
These "products may even require more due diligence than buying ’traditional’ hedge funds that have years of demonstrable track records and can often use a much wider spectrum of instruments to not only generate returns, but also manage risk," said Bruno Schneller, chief investment officer at fund of funds group Skenderbeg Alternative Investments.
Research firm Preqin estimates more than 100 liquid alternative funds have been started so far this year.
While the universe of liquid alternative-investment managers is expanding rapidly because they offer investors the convenience of mutual funds and the potential advantages of alternative investments, not all are created equal. Their proliferation has also attracted scrutiny from regulators, who are considering new rules to ensure mutual funds’ migration into complex strategies doesn’t pose risks to the financial system.
In the three months through September, the MSCI ACWI Index, which measures the overall performance of global equity markets, declined by almost 10 percent as China surprised investors with its currency devaluation. Liquid alternative funds tracked by Preqin lost about 3.5 percent, while hedge funds declined by almost 4 percent on average.
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