Liquid Alternatives Feel More Fluid to New Investors

Investors Seek Greater Flexibility With Alternative Funds

Liquid alternatives are a relatively new group of innovative and controversial investment products. They allow average investors to use investment strategies that were previously only accessible to accredited investors through private fund structures.

Also known as ‘liquid alts,’ these funds are becoming increasingly attractive to investors in today’s economic climate.

What Is a Liquid Alternative Investment, Exactly?

According to the Financial Industry Regulatory Authority (FINRA), there is no single definition of liquid alt investments. The category can vary widely but typically includes publicly available investments such as:

• Real estate
• Commodities
• ETFs
• Start-ups.
• Distressed debt

They are ‘liquid’ because investors can generally trade in and out of them with flexibility. This sets them apart from hedge funds, which are more rigid alternative investments..

A Primer to Liquid Alternatives

Liquid alternative investments are also known as alternative mutual funds and ‘40 Act Funds.’ They are usually comprised of mutual funds and exchange-traded funds that incorporate some successful hedge fund strategies. These strategies include global macro, long-short equity, and managed futures.

The funds are registered under the Investment Company Act of 1940. The Act requires portfolio managers to provide daily liquidity, estimate daily net asset value, and narrow the use of leverage and short selling.

Liquid alternative investment funds offer low-risk-adjusted returns that are not correlated to traditional investments or benchmarks. Alternative strategies designed to maintain a low beta make them less sensitive to certain market conditions. This allows them to offer more downside protection.

The 2008 Financial Crisis and the Launch of Liquid Alts

During the 2008 financial crisis, investors wanted to liquidate or rebalance the assets in their portfolios, but found that traditional assets were constrained by lockups and restrictions. In addition, investment scandals like the Bernie Madoff fraud, which robbed investors of billions of dollars, and the regulatory scrutiny of hedge funds ignited investor fears.

As a result, investors sought alternative investments that offered diversification through low correlation, increased oversight, and improved risk mitigation. Investor demands for daily liquidity and transparency increased. They also wanted to be able to sell off or shift investments around when needed. This transformed alternative funds and paved the way for liquid alternative investments.

Liquid Alternatives Offer Broad Appeal to a Broader Audience

Liquid alternatives initially appealed to institutional investors and individuals with high net worth. They especially attracted those who wanted hedge fund managers to adjust the transparency, fees, and lockup periods for hedge funds. Now, a broad range of investors can benefit.

Liquid alts are often positioned as hedge funds “for the masses.” According to Charles Schwab, liquid alternative ETFs attract a broader range of investors, beyond those that meet the regulatory standards of other public funds.

Liquid Alternatives in an Uncertain Market

The global economy in 2025 is defined by uncertainty, driven by various geopolitical and economic factors. As such, diversification has become crucial in allowing investors to buffer losses in any one asset class. Liquid alternative funds are also particularly compelling as a strategy to reduce stock risk.

However, inexperienced investors are advised to seek more education and assistance from skilled managers. Like any investment, the performance of liquid alts can fluctuate and there are pros and cons.

According to Morningstar, liquid alts have a high degree of return dispersion across nearly all categories. Picking the right category and the right fund is essential; the wrong choice could be more costly than investing in traditional asset classes.

Understanding the Risks in Liquid Alts

Liquid alternative funds are often considered ‘watered-down’ hedge funds. They typically enjoy less returns than traditional asset classes.

This is due to the illiquidity premium of traditional investments, where investors expect to be rewarded for taking on greater liquidity risks. Historically, illiquid alternatives tend to generate better returns overall than liquid alts. Over the past decade, liquid alternative categories have underperformed global equities, albeit at lower levels of risk.

However, liquid alts have the benefit of being quick to convert into cash when needed. They do not come with the ‘lock-in period’ of illiquid alternatives, which maintains portfolio stability but prevents investors from accessing the money they have invested.

Most experts ultimately offer caution. Liquid alternatives are best for investors with insight, time to research, high risk tolerance, and the ability to weather the short-term volatility of these investments. All the while, investors must be aware of the potential for underperformance.

New Strategies Forming for Liquid Alts

Liquid alternatives categories are still evolving. Every liquid alt investment strategy is different and requires a unique set of benchmarks.  Liquid alternative funds are relatively new, without long track records. As experienced alternatives managers continue to pursue liquid alternatives, their knowledge and expertise will progressively improve.

Know Your Goals and Speak With a Trusted Advisor

Investors considering liquid alternatives need to establish their objectives so that their strategies match their desired outcome. Pay attention to historical risk and return characteristics to determine what drives returns in different market conditions.

Most importantly, investors should work with experienced managers who understand the 1940 Act. Be sure to analyze the manager’s track record for executing successful strategies. Ultimately, finding the right manager is crucial to succeeding in liquid alternative investments.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Valuing Real Estate Assets
2. Ethical Issues In Real Estate-Based Bankruptcies / Insider Lease Agreements
3. Buying and Selling IP

This is an updated version of an article published on January 7, 2015 and updated on September 6, 2023. This article was most recently updated by the Financial Poise Editors.]

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