It's not too late to join the liquid alts party, Morningstar says

With stocks and bonds correlating in a move toward the floor, retail investors have been rediscovering the benefits of diversifying into mutual funds and ETFs that employ alternative strategies.

Even though financial advisers, in general, continue to express mixed views about the broad category of so-called liquid alternative funds, proof of the trend can be found in the flow of investor dollars.

This year through May, liquid alt funds experienced more than $21 billion worth of net inflows, putting the $192 billion fund category on track to surpass last year’s record inflows of $38.3 billion.

Looking at some of the standout performances by funds making up the broadly diverse liquid alts universe, Morningstar senior analyst Bobby Blue suspects there’s “a bit of performance-chasing going on.”

But he also agreed that “some of the strategy types have proven themselves to be effective diversifiers.”

Blue cited equity market neutral, style premia, which goes long and short across a range of asset classes, and systematic trends like managed futures as some of the stronger liquid alt strategies this year.

Against the backdrop of an S&P 500 Index hovering in bear market territory, anything in positive territory can look good. But a screen of the best-performing liquid alt funds so far this year suggests it’s not surprising investors are flocking in that direction.

The top liquid alt fund over the first half of the year is AQR Managed Futures Strategy (QMHIX), which is up more than 50%. But even the 10th best performer on the list, AQR Style Permia Alternative (QSPIX), is up more than 26% this year.

And the best part, according to Blue, is that “it’s absolutely still a good time to invest in this category.”

The caveat, however, is “if you do so, know what you’re doing,” he added.

“These strategies can diversify away from stocks and bonds, and that’s not something you want to try and time,” Blue said. “You need to carve out a strategic allocation for alternatives and understand the role they can play.”

On that note, Paul Schatz, president of Heritage Capital, agrees.

“Liquid alts has become that catchall phrase for allowing the public access to previously hedge-fund-only strategies,” he said. “They are intended to offer non-correlated funds and be all-weather, but I haven’t seen a consistent definition or how to properly categorize them.”

Tim Holsworth, president of AHP Financial, is also sitting this one out.

“I’ve had lots of experience and therefore I don’t use them, because I’ve never seen anybody that could successfully pull it off,” he said. “Generally speaking, it’s safe to say the industry has a helluva time playing the shorts successfully because there’s a major long bias in the markets.”

But Ashton Lawrence, a partner at Goldfinch Wealth Management, continues to be a believer in the diversifying benefits of alternatives.

“We utilize some alternative investments as bond proxies since their volatility, fluctuations and standard deviation are similar to some bond funds,” he said. “Conversely, we utilize some alternative investments as a diversifier to the equity holdings.”