Describing Liquid Alts: Multi-Alternative
The multi-alternative fund sector attempts to achieve returns through exposure to an aggregated portfolio of different alternative investment strategies. Although some index providers use the multi-alternative label to describe a wide swath of investing strategies, the term probably is most accurately attached to liquid alternative funds of funds, funds utilizing multiple submanagers, and statistical factor replication strategies.
The more straightforward multi-alternative approach is through a fund of funds structure, in which a parent RIC holds a diversified portfolio of more-specialized liquid alternative funds. This method facilitates transparency into the quarterly holdings of the composite portfolio and can provide a convenient vehicle for exposure to multiple alternative strategies. Other funds take a multimanager approach and take on a set of several subadvisors, often from existing hedge-fund or alternative investment management firms, and allocate a portion of assets to be managed by each submanager. Investors investigating the quarterly position statements of this type of multimanager fund typically will see the aggregated positions of all submanagers, which can slightly complicate performance attribution for investors in the parent vehicle. In both fund of funds and multimanager situations, consideration of the fees and investment selection ability at the parent and constituent levels of management is important.
Funds utilizing the statistical factor replication approach try to recreate the statistical factor exposures of an alternative index through a combination of traditional securities. Andrew Lo of MIT is one early and particularly prominent advocate of this approach to alternative strategy replication, in the academic literature and through association with investable products.[i] There is a legitimate concern that most factor replication strategies are exposed to the desired statistical factor exposures in only a linear fashion and may not capture the nonlinear exposures inherent in many underlying strategies that make significant use of options and other derivatives. Some approaches that fit models to the historical properties of aggregated alternative indexes may lack sufficient forward-looking ability, which is arguably one of the most valuable services provided by a skilled asset manager. The statistical factor replication approach may seem to offer the benefit of eliminating the extra layer of fees incurred by some fund-of-funds structures, but this may not be the case if the strategy implements its factor exposures via esoteric exchange-traded funds on the higher end of the expense-ratio spectrum.
1 See Hasanhodzic, Jasmina, and Andrew W. Lo. 2006. Can Hedge-Fund Returns Be Replicated?: The Linear Casehttp://web.mit.edu/alo/www/Papers/replicate.pdf
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