Fast-growing liquid alts asset class still needs to prove its worth, says Morningstar study
Morningstar has released a new report, Cross-Border Liquid Alternative Fund Landscape 2019, showing how the landscape for this fast-growing asset class has developed and transformed in the past decade, and what challenges lay ahead for investors and fund selectors in the asset class.
In the 10 years through the end of December 2018, the number of available open-ended alternative funds domiciled in Europe has risen by 76 per cent, which equates to 2,663 live open-ended funds in Morningstar's database currently. This growth is higher than for any other asset class. In terms of assets, alternative managers oversaw EUR420 billion of clients’ money at the end of 2018 – a tenfold increase in the decade, despite seeing stark outflows in the final quarter of the year.
Cross-border investors' demand for alternatives has clearly exceeded interest found in the US mutual fund market, where investors' regard for the asset class had already started to diminish in 2016, in part because of lacklustre performance of alternative products as well as rising interest rates in the US, which allowed investors to get a more decent yield from bonds.
Fees remain the main factor hampering the appeal of liquid alternatives, as they directly eat into investors' performance to dramatic levels as a percentage of net returns. The asset-weighted average ongoing charge of liquid alternative funds in Morningstar's database is 1.08 per cent with all share classes included.
Aberdeen Standard Life's Global Absolute Return Strategy (GARS) has had a major impact on the industry by driving investor attention to the segment, both directly and through the launch of other similar funds. More recently, performance issues have led to record-high redemptions from GARS.
Turnover has been high in the liquid alternative fund universe. On average, 324 new funds have been launched each year since 2009—more than one per each banking day.
There is a pattern of large flows going into funds with no or very short track records. In fact, over half of the trailing cumulative inflows in 2014-18 went into products launched in the same five-year period. The lack of proven strategies makes fund selection all the more challenging in this space.
Matias Möttölä, Associate Director, Multi-Asset and Alternatives, says: “Growth of hedge-fund-type strategies in a more liquid format has been fuelled by low bond yields, favourable regulatory changes, and vibrant product development. However, the liquid alternative funds universe is mostly filled with young, untested strategies with a low asset base, and high fees in relation to the returns delivered so far, which represents a challenge for fund selectors. Overall, investors need to be mindful that despite the large inflows, this space is still in growth mode and far from mature.”