Liquid Alt ETPs: success for alternative asset class exposure, less so for alternative strategies

• What are Liquid Alternative ETFs?
• What has adoption been like in the UK?
• Straightforward vs complex Liquid Alt strategies

 
Following the severe market turbulence of 2020, it’s worth taking a fresh look at “Liquid Alts” within the ETF space.
 
What are Liquid Alternative ETFs?
We define Liquid Alternative ETFs as any ETF that is:

1. is providing exposure to an asset class or strategy that is an alternative to long-only Equities or long-only Bonds
2. holds liquid underlying securities and is traded intraday

 
Rise in popularity post GFC
The increased popularity in the US of “Liquid Alts” came after the Global Financial Crisis and related liquidity crunch.  Following the crisis, there was a demand for portfolio diversifiers that were an alternative to bonds, but with a keen focus on liquidity profile of the underlying holdings.
In the US, the tradability of the ETF format meant that a broad range of “Liquid Alt” ETFs were launched, providing access to asset classes such as gold, commodities, and property securities, as well as long/short and more sophisticated “active” or systematic investment strategies packaged up within an ETF.  Liquid Alts became in vogue.
 
What about Liquid Alts in the UK?
First we need to distinguish between the “type” of Liquid Alts available.
We distinguish between those Liquid Alts that give exposure to an alternative asset class; and those that give exposure to an alternative asset allocation strategy.
In the UK, following the financial crisis, we saw the launch of ETFs that gave exposure to alternative asset classes – gold, commodities, property, listed private equity, and infrastructure, for example.    In this respect, the growth – in depth and breadth – of Liquid Alts has been impressive, particularly in the commodities and property sectors.
But when it comes to Liquid Alts to deliver an alternative strategy, the ETP format has not been popular: the preferred format remains daily-dealing funds.  Diversifier strategies, for example absolute return funds such as GARS, systematic trading strategies, long/short funds and funds-of-structured-products, have all been typically manufactured as funds in the UK rather than exchange traded products.
Reviewing the marketing in 2016, we were expecting the range of Liquid Alt strategies available to UK investors to broaden both in the mutual fund format and the ETP format.  As regards mutual funds, that has proven to be the case.  As regards ETPs, Liquid Alt strategies have failed to catch on.
Only a handful of liquid alternative strategy ETPs were launched, and they have largely failed to gain any traction.
 
Why is this?
Whilst straightforward Liquid Alt asset class ETPs have been successful in the UK, Liquid Alt strategy ETPs have failed to gain traction in the UK for 4 reasons, in our view:

1. In the UK there was less familiarity with ETFs as a fund format, which were and are generally perceived to be 1) single asset class “building blocks”, rather than strategies; and 2) index-tracking, rather than “active”
2. As a structural “diversifier” to a portfolio, there seemed little need for investors to trade liquid alt strategies on an intraday basis.  A traditional fund format would do.
3. In the advisory market, most platforms were not configured to trade or hold ETFs, meaning that funds were the structure of choice from a distribution perspective
4. Where Liquid Alt strategy ETPs have been launched, the actual investment strategy has failed to deliver.

 
Evaluating success: complexity fails
To summarise, in the UK, within the Liquid Alt ETF space, the more straightforward a product, the more traction it’s got.  Importantly, the reverse applies.
 
“Straightforward” liquid alt ETFs
Straightforward liquid alt ETFs provide liquid exposure to a specific asset class, or proxy for an asset class.
​
Fig.1. Liquid Alternative Asset Classes

​We find these “Liquid Alt” ETFs very useful building blocks to build in some diversifiers in a targeted and transparent way.
 
“Complex” liquid alt ETFs
The more complex liquid alt ETFs launched into the European market, have had far less success, and have ended up in the ETF graveyard..
Examples of complex strategies include: ETFs tracking a proxy of the HFRX Hedge Fund Index, an equity long/short ETF, and a market neutral ETF.

Fig. 2. Liquid Alternative Strategies

Liquidity lessons learned and relearned
There were painful liquidity lessons learned in the 2008 GFC.  Those liquidity lessons have been relearned for “less liquid alts” delivered by traditional fund formats, where investors were gated in direct property funds during Brexit in 2016 and Coronavirus this year.  By comparison, investors who chose property securities ETFs as their “liquid” way of accessing that exposure experienced no such gating.  Furthermore, the high profile gating of Woodford’s Equity Income fund and GAM absolute return bonds fund are further reminders as to why liquidity of the underlying asset, whether, within a fund or ETF, is so important.
 
Where next?
We see potential for increased competition in the single-asset class liquid alts, particularly infrastructure and listed private equity where there is little choice.
Whilst we expect some ETF providers to continue to create liquid alt trading strategies, we are not convinced that ETPs are the best format for these diversifiers.
Where we do expect innovation is in index-tracking funds that can be held on platform and provide a transparent, liquid and systematic approach to delivering true diversification strategies, as an alternative to opaque, higher cost absolute return funds.

NOTICES
Commercial Interest: Elston Consulting Limited creates research portfolios and administers indices that may or may not be referenced in this article.  If referenced, this is clearly designated and is to raise awareness and provide purely factual information as regards these portfolios and/or indices.