Are liquid alternative ETFs the next frontier for institutional investors?

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Copyright : Danil Chepko // 123RFwater splash on blue backgroundNew research from Greenwich Associates has found that institutional players have allocated US$47 billion to liquid alternative exchange traded funds, comprising a fair chunk of their allocation to liquid alternatives overall, which comes to US$882 billion.

That said, only about one in 10 institutions have experience investing in liquid alternative ETFs. “However, about the same share of institutions say they are actively researching liquid alt ETFs for possible use, and an even bigger proportion say they might consider investing in the funds in the next 12 months,” the report said.

As interest in ETFs has grown, with U.S. institutions having allocated more than US$1 trillion to them, so too has engagement with alternative asset classes. The study cited a projection that global allocation to alternatives could reach between US$15 trillion and US$20 trillion by 2020.

“Given investors’ steady appetite for alternative investments and their growing experience and comfort with ETFs, liquid alternative ETFs are emerging as a natural fit for institutional portfolios,” it said.

As these allocations grow, the study noted the significant appeal of adding further liquidity to alternative allocations. Indeed, the institutions participating in the study cited liquidity as the primary reason for using liquid alternatives.

However, they also cited a number of additional benefits. “First, they say that by facilitating easier access to a range of alternative asset classes, liquid alts enhance portfolio diversification. Next, relative to other alternative investments, liquid alts provide an important level of transparency. Liquid alts also have attractive fee levels. As a result of all these factors, institutions see them as having the potential to improve a portfolio’s risk/return profile.”

There remain some drawbacks to liquid alternatives, the study noted. In particular, institutional investors expressed concern over whether these assets would be able to maintain their liquidity during times of substantial market stress.

Currently, the most common use for liquid alternative ETFs is when an institutional portfolio is undergoing a shift in its alternative asset managers or making other tactical adjustements, the report said. Essentially, the ETFs act as a placeholder for the capital that would normally be allocated to less liquid alternatives, as these transitions can take multiple year periods to complete.

“Typically, institutions park assets in money market funds while transitioning from one alternative manager to another, or hold assets in physical cash or cash deposits. Liquid alt ETFs give institutions the opportunity to preserve broad asset class exposures during the transition phase.”

Liquid alternative ETFs are at a relatively early stage in their adoption by the institutional market, leaving them plenty of room to grow, the report noted.

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