Managers Should Revisit Liquid Alternative Offerings Amid Push for Increased Fees and Revenue Diversification
July 23, 2020 — Boston
Subadvisory mandates and innovative products can help managers expand retail reach; education is key to asset retention
The financial and operational impacts of the COVID-19 pandemic provide an opportunity for product manufacturers and advisors to re-evaluate their distribution of, and use of, liquid alternatives products, according to Cerulli’s latest report, U.S. Alternative Investments 2020: The Path Forward.
While liquid alternative products are exceptionally important to advisors who recognize their role as portfolio diversifiers, use of the products remains low. Advisors report allocating on average 5.6% to alternatives (not including commodities), and an even smaller portion of this is allocated to liquid alternative products. “Advisors allocate far less to alternative exposures than would be expected, especially given the increased availability of the products and advisors’ reported need for diversification and downside protection,” remarks Daniil Shapiro, associate director. He attributes limited adoption to several factors, including costs, investor performance chasing resulting in subpar returns, and complexity of exposures.
For managers, liquid alternatives offer fresh opportunities to generate above-average fees and diversify revenue opportunities, as well as to help institutional managers raise retail assets. However, given the difficulties that advisors face in allocating to liquid alternatives, Cerulli’s report encourages managers to focus future product development on less expensive products and more coherent exposures that are easier to explain and position to advisors, while also avoiding riskier segments. Shapiro suggests managers pay heed to the lessons learned from passive players: “Alternative product manufacturers should take a page from the passive management playbook and compete on simplicity and costs as opposed to a capabilities arms race.”
Managers can enter the market via the launch of their own products or through subadvisory mandates. Cerulli estimates that approximately $41 billion in hedge-fund-like liquid alternative assets—or 15% of the universe—was subadvised in 1Q 2020, indicating addressability. A key benefit for sponsors is attaining the highly specialized skills and expertise of a different manager— a particularly important demand given the complexity of the strategies—without developing the expertise internally.
Beyond subadvisory, Cerulli believes that ample opportunity remains to compete on costs and by launching innovative offerings, including private equity replication. While most liquid alternative assets are currently in the mutual fund vehicle, the accessibility of the exchange-traded fund and its key tenets of simple and inexpensive exposures can make it a strong distribution vehicle for liquid alternatives.
Given the challenges faced by advisors in selecting liquid alternatives products, Cerulli recommends that firms distributing liquid alternatives place maximum attention on education with the purpose of having advisors hold positions through drawdowns. “Not only do advisors need significant assistance in selecting an appropriate liquid alternatives product, they also need to be informed enough to be able to evaluate these strategies on an ongoing basis to ensure they stick with them through drawdown periods,” concludes Shapiro.