Success is transitory…In its Q3 Liquid Alternatives Observer, Morningstar reported that ‘uncorrelated liquid alternative categories all posted positive returns for the quarter while every nontraditional equity category posted negative returns’, suggesting that these funds ‘have too often failed the test of market reality.’ Excerpts of the report are presented below. Reprinted with permission. Access the full study here.
From an asset-allocation perspective, alternatives strategies and assets can make a lot of sense to a variety of investors. However, many of the vehicles and structures, such as private-asset or offshore hedge funds, are hard to access for investors and their advisors. They must therefore rely on liquid investments, whose premise is to democratize access to hedge fund-type strategies. These funds use a mix of investment strategies, securities, and techniques to offer something that differs from traditional long-only investments in equities or bonds, all wrapped in a familiar mutual fund or exchange-traded fund form. Unfortunately, liquid alternatives funds have too often failed the test of market reality. After more than a decade since they first surged in popularity—right after the global financial crisis—too many of them have disappointed investors in the European cross-border and U.K. markets that we analyze in this article.
The Last Shoe(s) to Drop
This point has been recently brought home by the closure of two of the best-known strategies in this space, Abrdn Global Absolute Return Strategies, or GARS, and Invesco Global Targeted Returns, or GTR. Abrdn announced in July that GARS would be merged into another fund after a strategic review of the multi-asset investment solutions business. It was characterized as one of the funds that “no longer resonate with clients.” Invesco conducted a similar strategic review, and on Sept. 27, 2023, the firm communicated its aim to liquidate all funds under the GTR strategy, pending regulatory authorization, “due to the lack of client demand.”
This outcome isn’t entirely surprising given the difficulties both strategies have experienced. The Morningstar Manager Research team dropped qualitative coverage of both the GARS and GTR strategies in March 2023. At that time, GARS had a People rating of Below Average and a Process rating of Average, whereas GTR carried an Average People rating and a Below Average Process rating. Both strategies promised a cash-plus-5% return in all market conditions. After the dust settled, investors were left with a fraction of that performance.
Taking A Step Back
Beyond the rise and fall of single strategies, financial news flow, and the vagaries of the macroeconomic backdrop, advisors and investors need to reflect on whether the equation of liquid alternatives adds up. Are their investment objectives simply too difficult to achieve in practice? They often promise to offer diversifying characteristics in a liquid wrapper for cheap fees relative to “real” hedge funds while providing a steady return stream. They are no easy feat. Meanwhile, some of these strategies are watered-down versions of preexisting hedge funds to fit the prevailing regulations (such as UCITS). Hence, in some cases, there are simply too many constraints to reasonably replicate the success of the hedge fund. In our 2021 Global Liquid Alternatives Landscape, we enumerated some of the key challenges that face liquid alternatives investors.
Liquid alternatives are, by definition, active strategies. As such, not only do they suffer from all the issues associated with active management, such as style drift and portfolio manager changes, but they can also be more complex to understand and time-consuming to analyze than traditional funds. Even if an investor can spot a good liquid alternatives strategy, how this fund is used in a portfolio is another key part of a successful investing outcome. And even if selection, timing, and sizing are done well, more bad things can happen. Several liquid alternatives funds have concentrated client bases and are therefore sensitive to the whims of a few investors. In other cases, a strategy’s success may bloat its assets to force modifications in the way it is managed, or success may raise the interest of better-paying competitors in poaching the portfolio managers.
Carbon Offsets vs. Carbon Credits: What’s The Difference?
If you’ve ever purchased a plane ticket, you’ve probably stumbled across (or, more likely, clicked past) a carbon offset. Carbon offsets are commitments from a third-party platform to invest in a project that counteracts the burden on the planet of what you’re about to buy. Offsets achieve this by funneling the proceeds from the purchase into renewable energy sources like wind farms or land-use projects like planting trees.
Carbon offsets often get conflated with another instrument that shares a similar name: carbon credits. Both are the subject of increasing interest from investment firms. For example, Pimco features a small allocation to carbon credits in its Pimco Commodity Real Return PCRIX, and KraneShares offers KraneShares Global Carbon Offset ETF KSET. Both funds argue that investments in carbon may allow ordinary investors to benefit financially from decarbonization efforts. Even so, carbon credits and carbon offsets are fundamentally different, with implications for investors seeking to understand how these instruments work in practice.
It starts with the philosophical problems that each security is trying to tackle. Carbon offsets are designed to help consumers counteract the impact of expected or past emissions. Carbon credits, meanwhile, make it more expensive for companies in regulated industries to pollute by charging them per unit of carbon they emit, which has the effect of dis-incentivizing future emissions.
What Are The Takeaways For Investors?
Although they are very different, what carbon credits and offsets do have in common is that neither carbon offsets nor carbon credits charge a price that could be considered punitive, and there’s no guarantee that they ever will. Proponents of an allocation to carbon-linked securities argue that carbon securities are a “sure thing” because, conceptually, the price of carbon has to rise in order to meet climate agreements. But this conclusion rests on the assumption that the price of carbon can rise.
Access the complete report here.