What grew faster than the S&P 500’s 30% rise in 2013?

Liquid alts: A Barclays study puts the increase in assets at 43% last year, bringing the total to $137 billion. Depending on definitions, some reports put liquid alt assets even higher. By any measure, some advisors are adding these funds to clients’ portfolios.

“We’ve expanded our liquid alt holdings recently,” says Marilyn Capelli Dimitroff, director of wealth management at Planning Alternatives, a wealth advisory firm in Bloomfield Hills, Mich. “Money market funds pay almost nothing now, fixed-income investments have potential losses if interest rates rise, and equities are at record highs so we have been looking for alternatives.”

Her firm has not been very active in hedge funds, Dimitroff says, because of their high required minimum investments and their lack of liquidity. “Rather than hedge funds,” she adds, “we brought in more liquid alts to reduce our dependence on traditional asset classes, where forecast returns are relatively low.” Client allocations to such vehicles were minimal but they’ve now increased to the point where exposure is meaningful.

MULTIPLE CHOICES

Liquid alts come in many forms, including open-end mutual funds, closed-ends and ETFs. Not only are they liquid, they also offer transparency, modest minimum investments and familiar fee structures. Typically, liquid alts follow a hedge fund-like strategy—market neutral, long-short, arbitrage and so on. There are dozens of such funds on the market, and choosing among them can be a challenge.

“Step one was identifying the liquid alts we liked, and might want to use,” says Jason Close, director of investments at Planning Alternatives. “We looked at performance records, costs, strategies, process and the management team, in order to select the ones we’d investigate further.”

The next step was looking under the hood of apparently desirable funds to determine a risk profile. This involved checking historic volatility and applying other metrics. “We wound up with liquid alts in four areas,” says Dimitroff. “Those are long-short stocks, long-short bonds, managed futures and multi-strategy. It’s a mini-portfolio of liquid alts, which we allocate to match each client’s risk profile.”

PAYING FOR THE PURCHASES

Close notes that funding an increased commitment to liquid alts was another concern. “We had to figure out how to source the cash and make room for these funds,” he says. “We decided to move money from equities and fixed income, in proportion to a client’s allocation.” For example, if a client with a 60-40 asset allocation, equities to fixed income, was to move $50,000 into liquid alts, $30,000 would come from stocks and $20,000 from bonds.

From picking potential funds and assessing possible future risk, expanding the firm’s commitment to liquid alts required a great deal of time and effort. “We believe it has been worthwhile,” says Dimitroff. “These funds are now a viable part of the asset allocation for all of our clients, and we expect them to add value.”

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.