While traditionally thought to be the preserve of professional or institutional investors, liquid alternatives can play a key role in portfolio construction for retail investors, according to BlackRock’s Michael Gruener.
Gruener, head of BlackRock's Europe, Middle East and Africa retail business, said that liquid alternatives can provide diversification, reduced volatility and downside protection for investors willing to consider them.
As an area of the market that has long been eschewed by retail investors, in part due to their complexity and riskier nature, alternatives have played a lesser role in portfolios.
However, in a late-cycle environment, returns have become more difficult to come by and some bonds are trading on negative yields, a particular challenge for income investors.
“What option does that leave a retail investor? Does every retail investor have to be invested 100 per cent in equity? Probably not,” he said.
“So, what do you do about the fixed income allocation? I’m not going to put it in bonds, where I lose money every day.”
As such, an allocation to liquid alternatives might now be a prudent idea.
Liquid alternative products, which have a similar risk profile, can be a much better option for investors, said Gruener.
“A lot of our clients who are managing money would tell you they aim for 25 per cent of the portfolio in alternatives,” said BlackRock’s Gruener.
“If this seems relatively high, it’s because most fixed income instruments with their negative yields are not doing the job the clients need them to do.”
This, he explained, was one of the reasons behind the recent growth of the liquid alternatives market.
Source: Preqin
As the Investment Association noted more recently, there has been significant growth in private market assets over the past decade, having more than doubled since 2010.
The liquid alternatives space covers a range of different strategies and asset classes and this flexibility can be a great advantage, Gruener said.
“Take, for example, an equity long/short portfolio, where a portfolio manager can not only go long in stocks but also go short in stocks because he can do that, he limits the beta and the correlation to a portfolio that follows a long-only strategy.”
Indeed, provided the manager did the right longs and the right shorts, Gruener added, “the end result is pure alpha, provided the manager is very good”.
As such, the importance of selecting the right manager cannot be overestimated, Gruener stressed.
“Managememt skills are important,” he explained. “Not every liquid alternative manager is good.”
However, one of the most important characteristics of liquid alternatives is that they can be quickly sold and traded with little difficulty.
This liquidity is an important aspect, BlackRock’s Gruener concluded as “many retail investors cannot stomach seven years of lock-up”.