Financial planners should carefully consider the benefits and disadvantages of using hedge fund beta strategies for their clients' alternatives allocation, according to research houses.
Standard & Poor's Fund Services (S&P) alternatives strategies sector head Michael Armitage said while hedge fund beta products offered a unique value proposition, clients could potentially be sacrificing good returns.
"I think alternative beta definitely has its place. Some of the products are certainly cheaper, offer daily liquidity and potentially full transparency in terms of their investment algorithms and what underlying holdings they have," Armitage said.
"But are advisers willing to give up the potential outperformance of alternative alpha strategies?"
Alternative beta products are designed to generate the same risk and return profiles that normal hedge fund strategies have delivered over time, but generally charge lower fees and have better liquidity.
Zenith Investment Partners head of alternatives research Daniel Liptak said investors needed to choose the product that best suited their needs and not concentrate on beta versus active arguments.
"Our view, as always, is that there is certainly more alpha from active strategies, but this alpha comes at a cost of higher fees and illiquidity," Liptak said.
"Most of the beta products are an attempt to address liquidity demands of investors, with many fund of hedge funds now using some variation of hedge fund beta to provide more attractive liquidity and lower fees."
Lonsec senior investment analyst Deanne Fuller said the firm regarded the hedge fund beta concept as superior to replication strategies and investing in hedge fund indices.
"Essentially, hedge fund beta examines a number of hedge fund strategies and identifies and implements the 'bread and butter' trades that underpin each strategy," Fuller said.
"While the underlying strategies are less likely to perform as well as a dedicated manager specialising in a particular strategy, the trade-off to investors is that this strategy is substantially cheaper."
Armitage said some alpha managers deserved the fees they earned and advisers should look at their net-of-fee risk-adjusted performance.
He also said several alpha managers needed monthly or quarterly liquidity windows for the particular strategy they were employing.
"Again, advisers need to look at whether they are returning above the liquid strategies as compensation for that illiquidity," he said.
"So whether it's alternative beta or alpha, it depends on the individual, the risk they are willing to take for higher returns and what their liquidity needs are."
S&P has noted increased use of the hybrid model, where multi-manager funds incorporated alternative beta products within portfolios using a core and satellite approach.
"The use of lower-cost alternative beta strategy products yields the bulk of an expected alternative return profile for a low fee. The savings at the underlying manager level grant the product an overall lower fee structure," Armitage said.
"But we caution investors against focusing solely on fees. Lower-fee products do not guarantee a better outcome for investors on a post-fee basis."
