In word and in deed, the asset management industry embraced the "liquid alternatives" category like never before in 2013, rolling out dozens of mutual funds and ETFs under the liquid alts banner.

As the provider of the first no-load, open-end hedge fund replication mutual fund (IQHIX) and the first family of hedge fund replication ETFs (including our flagship ETF, QAI) to be listed in the U.S., we've had a unique vantage point from which to watch the liquid alts revolution unfold.

The response from the market to the availability of these new strategies has been enthusiastic. Assets have flowed into the space as investors and advisors seek everything from downside protection to non-correlated returns to fixed income alternatives. The IndexIQ family of funds alone has gathered more than $1 billion in assets and we firmly believe that we're still in the first or second inning when it comes to investor interest in the category. So what needs to happen next to accelerate this growth and take liquid alts to the next stage in its evolution? I see three areas where fund providers can help move things forward.

Focus #1: Education

The benefits of various liquid alts approaches are clear to those of us who make it our business to construct (and deconstruct) these vehicles, but are often less obvious to investors and the advisor community. While the explosion in products has brought with it more choices and far better access to institutional-quality strategies than advisors and their clients have ever had before, each of those choices represents work for either an advisor or a self-directed investor, who must understand what that product is, how it is structured, what it is designed to do, and where it might fit in a portfolio.

We've made education the number one component of our outreach efforts, and being cognizant of the time constraints facing so many advisors today we've sought to maximize the efficiencies offered by technology, with our IQ Inform webinar series and IQ

The liquid alts space provides some powerful tools for money managers and advisors, but those tools need to be well understood and not misconstrued or conflated with other issues driving investor sentiment.

Focus #2: Messaging

There is a very real danger in ceding the messaging around the liquid alternatives product category to the, for lack of a better term, "illiquid" versions of an investment strategy or approach. For example, in recent months, the hedge fund industry has faced a wave of negative headlines and magazine cover stories focused on the how hedge funds have, in the aggregate, dramatically underperformed the broad equity markets over the last several years. Some of this backlash towards hedge funds may be deserved. Investors, after all, have become much more cognizant of the fees that hedge funds have been charging and are asking hard questions around lockups, gates, and the lack of transparency that has long been a defining characteristic of the hedge fund industry.

However, some of the backlash may result from a fundamental misunderstanding of what many hedge funds are designed to accomplish. When looked at through the prism of a hedge fund's original intent - which was to act as a true hedge against market downturns - the industry has been wildly successful. Hedge fund replication vehicles as well have performed largely as designed, smoothing periods of volatility, protecting against significant downside risk, and allowing some exposure to upside potential. Replication vehicles, one of the first entrants into the liquid alts arena, have also done all of this without the lock-ups, gates or high fees of traditional hedge funds, and with dramatically increased transparency.

Yet that very term "hedge fund" or "alternative investment" runs the risk of bringing too much extraneous baggage to the discussion in an investor's mind, and is something we need to be cognizant of and ever vigilant in discussing and explaining. It would be naïve to think this is an easy thing to do since the argument against hedge funds which is making so many waves, namely one of underperformance, is seemingly so black and white, which brings me to...

Focus #3: Benchmarking

Absolute return products offer an interesting window into some of limitations of traditional benchmarking when applied to the liquid alts space. After all, why would the broad stock market be the best gauge for success when looking at these products when it historically has had more than three times the annualized volatility of most absolute return strategies? It's important to note that absolute return funds, and so many of the other liquid alternatives now gaining favor, were initially the province of institutional investors, who in many cases were trying to match long-term asset growth to future liabilities in a relatively conservative fashion. For many of these investors, hedge funds were not "shoot the lights out" strategies. Thus, it makes sense to consider a change in perspective in evaluating alternatives, particularly in terms of looking beyond long-only stock market returns as a benchmark.

If money managers and advisors understand liquid alternatives and if can compare their respective returns to appropriate benchmarks, the benefits of these vehicles will only become clearer, and the next phase of growth will be ready to begin.

Adam Patti is the CEO of IndexIQ (www.indexiq.com). 

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.