It seems like everyone is talking about liquid alternatives. If you read the news or listen to industry pundits, you can't help but hear about their momentum, and many mutual fund sponsors are looking to capitalize on the opportunity. While not everyone agrees on how big the market will be, there is a general consensus that liquid alts are one of the fastest growing asset classes in the industry. A recent survey from Barclays showed that liquid alts grew at a significantly faster pace than hedge funds last year, and Barclays and Citi both project assets in the space will reach nearly $1 trillion by 2018.
With more retail investors and retirement plans looking for the diversification benefits of alternative strategies with the safeguards of a '40 act structure, there doesn't seem to be any slowdown in sight. And while the demand is strong and seemingly only getting stronger, mutual fund sponsors who think they can simply launch a fund and expect investors to come with assets in tow could be in for a rude awakening. Being in the space and being successful in the space are two different things all together.
The reality is that a small number of funds are gathering the lion's share of the assets, while the overwhelming majority of funds are launching with limited success. In fact, according to Strategic Insights, 25 funds accounted for 71% of all inflows into the liquid alts space last year; another 36 funds accounted for 30% of inflows; and 438 funds accounted for just 6% of 2013 inflows. If those numbers seems off, it's because another 38 funds accounted for negative flows of 7%.
To help mutual fund sponsors looking to stand out and gather assets in the increasingly crowded liquid alts market, below is a set of critical but often overlooked insights necessary for achieving long-term success.
1. Education Drives Distribution. As the liquid alts market has developed, the role of distribution has evolved from sales to education. Given the increasing complexity and diversity of product options, the best liquid alts wholesalers are the ones who are the most financially savvy. The sponsors who understand this changing distribution dynamic and identify partners that can educate their end audience about their offering and its advantages will be the ones who gain assets and traction in the maturing liquid alts landscape.
2. Dabblers Don't Succeed. Success requires dedication to the product, relationships with experienced business partners who understand the strategy, and a commitment of resources to build out the infrastructure it takes to meet regulatory requirements and investor expectations. Commit to the strategy and fund the business because savvy investors can sniff out a dabbler miles away. There are too many options for an investor to commit their assets to a manager who won't commit themselves.
3. Illiquidity Breeds Complexity. It's critical that liquid alts sponsors choose a service provider that has the expertise and the technologies to support their strategy and guide them through the process of meeting liquidity requirements. Sponsors who don't have a firm understanding of liquidity requirements will inevitably increase risk, increase cost and decrease the chances of success.
4. Some Strategies Are Too Costly. The first question sponsors need to ask is, "will my strategy work in a '40 Act structure?" If the answer to that is yes, the next question should be, "will it be viable from a cost standpoint? " That's where the process may get a bit more complicated. There are plenty of strategies that technically work in a mutual fund structure, but the operational needs and associated costs may make the fund's cost structure too high to be attractive to investors - and the more complex the strategy, often the more cost involved in executing.
For instance, some multi-strategy funds require more extensive risk processes, demand multiple custodians or increased fund accounting needs. All those come with additional costs. Sponsors must consider costs, processes and resources in a competitive context because while some strategies may work in theory, they can be too expensive to gather assets in reality.
5. Successful Sponsors Think Long-Term. There are many options to consider from an operational standpoint, but the more a manager can think long-term the more likely they will be proactive in setting up the right partners and processes. Following through on that will lower costs and increase the chances of sustaining success over the long haul.
When it comes to succeeding in the liquid alts business or any business for that matter, the devil is often in the details. While some of the points above may seem like common sense considerations, unfortunately many sponsors don't know what they don't know. There's no question that the opportunities in the liquid alts market are abundant and only getter greater, but the competition is getting stiffer as well. As convergence takes hold, competition is ramping up and sponsors' margin for error is shrinking.
The factors outlined above will likely be the difference between gathering assets or getting left behind. So take advantage of the insights many new entrants to the retail space overlook and create a clear site line to success in the booming liquid alts market.
Dave Carson is vice president and director of client strategies and president at Ultimus Managers Trust.