A relatively new category of exchange-traded fund is poised to hit it big, according to Greenwich Associates.
Institutional investment in so-called liquid alternative ETFs — including products that seek to mirror hedge funds — will more than double, to $114 billion, over the next 12 months, analysts led by Andrew McCollum wrote in a report Monday.
The study was commissioned by IndexIQ, part of New York Life Investment Management, which runs two of the largest ETFs with hedge fund-like strategies, data compiled by Bloomberg show.
Pension funds, endowments and other large investors currently have $882 billion invested in liquid alternatives — a catch-all pot that encompasses everything from hedge funds and real estate to private equity and infrastructure — but only about $47 billion of that is in ETFs, Greenwich found.
However, that gap could soon shrink as almost 20% of institutions not currently investing in these funds told Greenwich that they will consider using them in the next 12 months.
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"The interest to allocate more to liquid alternative investment strategies overall is really investors' need to get a diversified source of return to reduce volatility in their portfolio, especially as we are getting to an extended bull market," said Kelly Ye, director of research and alternative investments with IndexIQ.
The firm's IQ Hedge Multi-Strategy Tracker ETF and IQ Merger Arbitrage ETF together oversee more than $1.7 billion.
Alternatives can help diversify portfolios because their returns aren't necessarily correlated with the movement of the stock or bond markets, where most investors deploy the majority of their capital.
But some of these strategies can be hard to access, hence the appeal of a daily-traded ETF — or even mutual or closed-end funds — to make investing easier.
Many of the 107 fund professionals questioned by Greenwich are interested in ETFs for liquid alternatives because of their enhanced liquidity, improved portfolio diversification and heightened transparency. However, just one in 10 had actually used these funds, and only for a small proportion of their assets.
Complexity could be a roadblock to increased adoption, said Shana Sissel, a senior portfolio manager at CLS Investments, who specializes in alternatives. Any underperformance by these strategies can be difficult to explain to investors, she said.
Still, more people are starting to ask about liquid alternative ETFs, said Gary Stringer, chief investment officer at Stringer Asset Management.
"People are looking around for areas to generate some kind of return that is better than what the traditional fixed-income market is offering," he said.