Driven by growing investor appetite for private market exposure without the traditional illiquidity constraints, a new wave of liquid private market funds has emerged in recent years.
However, as bfinance previously explored in a July report, these funds can carry some risks, such as potential liquidity mismatches and diluted returns.
The consulting firm explained that some of these newer evergreen funds lack transparent performance histories, and their true return alignment is obscured by layered fees and complex structures.
In particular, it viewed modern evergreen funds – which offer monthly, weekly or even daily liquidity – as particularly challenging due to the natural incompatibility of liquidity in private markets.
To address these shortcomings, bfinance has suggested liquid alternatives as a complementary investment strategy, which could offer a more dependable source of liquidity and diversification when used alongside evergreen and semi-liquid funds.
This is particularly true since current market conditions have been conducive to alpha generation since the post-COVID era began, the firm stated.
Bradley Budd, senior director of bfinance Access, and Toby Goodworth, the firm’s managing director and head of liquid markets, told InvestorDaily that bfinance’s advice to investors is to concentrate on fundamental principles to tackle portfolio challenges, rather than “chasing innovation”.
“Liquidity itself is not intrinsically valuable but offers flexibility to adjust exposure and non-portfolio client needs e.g. the ability to monetise gains rather than NAV-based returns,” they said.
Based on the fundamental principles of robust portfolio construction, the pair asserted that securing liquidity from multiple sources is “inherently more robust” than relying on a single source.
Diversification benefits
bfinance outlined that liquid alternative strategies, often referred to as hedge funds, essentially aim to generate returns that are independent of traditional stock and bond markets.
Encompassing a highly diverse range of approaches, these strategies employ a wider, less restricted array of investment techniques, including long/short investing, relative value investing or the use of derivatives.
The firm categorised liquid alternative returns into three main styles: market independent, convex/divergent and directional.
While market independent strategies aim to generate alpha-rich return streams that are largely independent of traditional risks, convex/divergent strategies are designed to produce returns primarily in stressed market conditions.
Meanwhile, directional strategies seek to capture desired idiosyncratic return components that would otherwise be difficult to access without some embedded beta exposure.
Budd and Goodworth identified market independent and convex/divergent strategies as particularly strong portfolio diversifiers, especially when stocks and bonds prove unreliable.
“The absence of beta, or in some cases negative beta, can be value additive to portfolio returns over the long run,” they said.
In contrast, they explained that liquid private market funds are still directionally exposed, often even more so than their fully illiquid counterparts. Instead, their diversification benefits stem from different pricing mechanisms to traditional risk assets.
While each approach has its advantages, the pair said the key was that any alternative allocation should bring “usefully different return streams”.
They added that liquid alternative allocations need not be complex or burdensome to manage.
“Whilst a fully fledged hedge fund portfolio can offer highly tailored outcomes, the important exposures – market independent and/or convex/divergent strategies – can be directly accessed,” they said.
Given these funds are typically well diversified across asset classes and global in scope, they argued that diversification can be “reliably achieved” within a few line item positions.
“We have helped wealth clients build out such exposures using between 1–5 line items,” they added.
Budd and Goodworth concluded that despite being overlooked for some time, liquid alternative strategies present a unique tactical opportunity for wealth managers looking to avoid the “liquidity trap” in product innovation.
“It is not that we advocate liquid alternatives over liquid private markets, rather wealth managers can consider using both in parallel.”
