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Asset Allocation

Inflows Boost Liquid Alts in a Troubled 2022

After lagging during the stock bull market, the asset class now scores decent returns, says Morningstar.

By Larry Light



Liquid alternatives, which aren’t correlated to stocks and bonds, have been inching up in their acceptance by institutions, although they have a long way to go. Taking off after the 2008 financial crisis, they found acceptance among retail investors, but less among asset allocators, who can run their own alternatives strategies.

Only over the past two years have liquid alternatives, originally known as hedge funds for the masses, increased their sales appeal, both for retail and institutions. Reason: The big traditional assets, stocks and bonds, have both performed poorly of late. That leaves an opening for something completely different.

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A torrent of investments, some from institutions, has been sluicing into liquid alts mutual and exchange-traded funds, according to research group Morningstar. Through this year’s first half, the space garnered $23.3 billion in net inflows, besting the $18.4. billion from the comparable period in 2021.

That is quite a bounce from 2020’s showing, an outflow of $3.2 billion. From 2015 to 2020, outflows prevailed.

The top liquid alts funds nowadays are futures-oriented, a strategy called systemic trend. The performance leader for 2022 is AQR Managed Futures Strategy HV 1, which is up 50% through July 20, per Morningstar. The fund invests in 100 futures and forward contracts around the world, using a mix of equities, fixed income, currencies and commodities.

Historically, though, the nine-year-old fund didn’t have a great returns record during the great bull market that petered out at the end of 2021. It lost 2% last year and 0.65% in 2020. But in topsy-turvy 2022, the fund has come into its own, with the 50% gains.

This year, Arrow Managed Futures Strategy A and Guidepath Managed Futures Strategy Institutional are second and third in returns, ahead 44% and 39% respectively.

These assets have been very volatile, to say the least. Commodities, for instance, have been strong this year, although their prices have waned lately. The AQR fund aims to do well in both good and bad markets—with a robust shorting program for the latter.

Not all liquid alts funds have done well. Example: those in the long/short category, which is down 9.4% this year, by Morningstar’s count. This demonstrates “there’s still some equity market risk inherent in some of these strategy type,” says Morningstar analyst Bobby Blue.

Indeed, liquid alts have displayed some performance chops periodically in the past. For instance, in 2020’s first quarter, when the pandemic took hold, the S&P 500 drooped 20% and liquid alts lost just 9%, a Goldman Sachs Asset Management study found.

In 2019, liquid alts constituted about 4% of institutional assets, with average allotments ranging from a high of 6% of total assets among public pension funds to a low of 2% among corporate programs and outsourced CIOs in the U.S., a Greenwich Associates study detailed. The consulting firm has estimated that the institutional share has doubled since then.

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Home > News > Risk > So What Is the Fed’s End Game on Rates?
Risk

So What Is the Fed’s End Game on Rates?

Commonwealth’s McMillan thinks it has two half-point increases ahead, and that’s it.

 

By Larry Light



Wall Street soothsayers are trying to figure out when the Federal Reserve will end its tightening drive—and perhaps lower rates to blunt a recession. To Brad McMillan, CIO at Commonwealth Financial Network, the likelihood is strong that two more hikes, of a half percentage point each, are ahead. Then, he predicts, the Fed stands pat.

How come? Two reasons, in McMillan’s view: first, that high inflation, the impetus for the rate boosts, will ebb by year-end, and second, that the threat of recession is worsening, thus requiring a dovish, or at least less hawkish, policy ahead.

If true, the inflation abatement would be good news for beleaguered consumers. The Consumer Price Index soared 9.1% in June, from 12 months earlier.

McMillan’s rate forecast tracks that of the futures market. Following the Fed’s just-announced decision to increase its benchmark rate by 0.75 point, the market’s expectation is that two more half-point boosts will follow. That would put the federal funds rate between 3.25% and 3.5%.

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In a research note, McMillan depicted talk of a near-term end to hiking as premature. “It is still too early to pull back, and the Fed won’t,” he wrote.  Yet it isn’t too early, he added, to anticipate what comes after the two half-point increases he sees as next. That, he said, “is likely to be less hawkish.”

“Longer-term interest rates never went up that much and are now pulling back—a sign that current higher rates are not expected to last,” he observed. Indeed, the 10-year Treasury bond now yields 2.8%, down from 3.5% in mid-June.

On inflation, McMillan is on Team Transitory 2.0, meaning that we have seen the worst and those high prices will calm down. “Some of the key inflation drivers (e.g., the price of gas) have declined, and supply chains continue to improve, driving supply up even as demand eases,” he wrote. With the CPI at a 40-year high, he continued, “the Fed has pushed rates up quickly, but there will be much less need to do so once inflation moderates toward the end of the year.”

The public’s inflation expectations are a little less dire lately, he pointed out. And this is important, because what people foresee can be a self-fulfilling prophecy—as happened in the double-digit-plagued 1970s.

The University of Michigan’s poll for July shows that consumers see inflation moderating to 5.2% over the next 12 months, down from 5.3% the month before. And over a five-year timeframe, they see it slowing to a 2.8% pace, the lowest in a year and down from 3.1% in June. By next year, McMillan said, “the Fed’s job is largely done.”

Key to the Fed’s strategy is that higher rates will cool consumer demand, and that is occurring. Still, McMillan cautioned, now is not the time for the central bank to contemplate lowering rates as an economic stimulus.

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