The conventional investment categories, i.e., stocks, bonds, and cash, can provide high returns. However, piling these up can be highly risky for investors. Therefore, some investors usually go beyond these investment categories to diversify their portfolios. However, they may lose some benefits that these investments provide, such as liquidity. For that, investors may look into liquid alternatives. However, it is crucial to understand what alternative investments are first.
What are Alternative Investments?
Alternative investments are assets that do not fall into the conventional investment categories. Therefore, these include investments that are not stocks, bonds, or cash. Instead, alternative investments may consist of private equity, real estate, commodities, etc. However, these investments are more suitable for wealthy investors rather than normal ones.
Alternative investments provide investors with a great opportunity to diversify their portfolios. They aren’t a part of conventional categories and, therefore, can decrease the risks that investors undertake. However, alternative investments do not get traded frequently on the market. For that reason, investors consider them to be illiquid. However, liquid alternatives change that.
What are Liquid Alternatives?
Liquid alternatives, or liquid alts, are alternative investments that are liquid. These may include mutual or exchange-traded funds. Usually, liquid alternatives provide the same benefits that most other categories of alternative investments do. However, they also have a higher trading frequency, meaning investors can buy and sell them easily. Therefore, they are more liquid.
Liquid alternatives also provide other benefits to investors. Usually, these investments require lower capital than typical investments. Similarly, they are more widely available to investors of all categories. Some alternative investments may only be available to wealthy or accredited investors. However, the same does not apply to liquid alts.
How do Liquid Alternatives work?
Liquid alts provide investors with alternatives to conventional investment categories. However, they also focus on allowing investors to acquire liquid investments. The primary reason for that includes the frequency with which these investments get traded. While not at the same level as conventional investment categories, this frequency is high enough to allow investors to invest without restrictions.
As mentioned, liquid alts include hedge or mutual funds. These funds may employ various investment techniques that differ from other funds. For example, fund managers may use long/short investing, derivatives, leverage, etc., to maximize the returns they generate for investors. However, they will still focus on providing investors with diversification and liquid investments.
What are the drawbacks of Liquid Alternatives?
Liquid alternatives provide features such as diversification or liquidity. However, they also come with some drawbacks. These investments usually offer lower returns compared to conventional investment categories. This drawback also relates to alternative investments. Furthermore, hedge funds may limit the period for which investors can withdraw or deposit their money. This limit may be counterintuitive to the liquidity these investments offer.
Similarly, liquid alternative funds usually charge higher fees compared to others. It may not be ideal for investors looking for inexpensive alternative investments. Some funds may also include investments in non-liquid assets, which counteracts the advantages investors can get. Lastly, the demand for liquid alts has increased over the years, which has resulted in slowed market growth.
Alternative investments allow investors to choose from investments beyond the conventional categories. However, they are not as liquid, which can be a drawback. Liquid alternatives are alternative investments that allow investors to counteract that problem. These investments get traded more frequently and are, therefore, more liquid. However, that has some drawbacks.