Describing Liquid Alts: Alternative-Asset Beta (FX, Commodities, MLPs and beyond)
The alternative-asset beta family of related liquid alternative strategies invests in alternative assets such as foreign exchange, commodities, and energy infrastructure. Ideally, these investments will provide attractive risk-adjusted returns that are uncorrelated with traditional equity and fixed-income markets.
In terms of daily volume, foreign exchange is the most active of all markets, with an average daily spot-market volume exceeding $5 trillion.1 A number of liquid alternative funds specialize in exposure to foreign exchange, typically aiming to exploit interest-rate and relative-value differentials between currencies. A portion of these funds specialize in emerging market currencies, which can be viewed as a risk asset and typically offer higher interest rates than more developed economies.
Despite structural requirements for offering commodity exposure through an RIC vehicle and several years of trailing returns for broad-based commodities investments as an asset class, a number of commodity-focused alternative strategies are available. Some of these funds combine investments in derivatives tied to the underlying commodity with equity investments in correlated industry sectors.
We believe that funds specializing in master limited partnerships (MLPs) are best classified within the liquid alternatives universe as a class of alternative beta. MLPs are publicly traded limited partnerships that can offer the tax characteristics of a limited partnership with the liquidity of an exchanged-traded instrument. U.S. law allows for corporate pass-through treatment for MLPs engaged in a specified set of business activities, primarily the extraction, processing, and transport of energy resources. As many of these companies are structured around low volatility “toll” businesses such as pipelines, MLP investments often are considered a diversifier and potential fixed-income substitute.
Investment in individual MLPs offers tax benefits to individual investors in certain circumstances, but investors should be aware of potential complications. These were highlighted during Kinder Morgan’s 2014 acquisition of its subsidiary partnerships, which triggered unanticipated taxable events for many investors. Mutual funds that take positions in a portfolio of MLPs face an entirely different set of tax challenges because any distributions from the constituent MLPs must pass through the mutual fund’s corporate entity.
