What Does A Next-Generation Liquid Alt Look Like?

As a kid who played whatever sport was in season, when the weather didn’t cooperate, I brought that passion inside to the latest sports video game. It was routine for me to battle my friends in games such as Madden NFL, NBA 2K, MLB The Show, and FIFA. Even the NHL made an appearance from time to time, which was peculiar for a southern kid in the 1980s.

One of the most popular aspects of these games is the ability to create a player. The create-a-player function, as it is commonly called, allows for nearly limitless customization. Your player can be tall, short, big, or small. They can be your doppelganger or look wildly different. Once created, they can be drafted and controlled like any other player, allowing the average Joe to live vicariously through their creation.

The idea of creating an ideal player got me thinking about the equivalent from an investment perspective.

Is Create-a-Player Flexibility Possible for Liquid Alts?

For most financial advisors, equities and fixed income are historically the dominant portfolio constituents due to their mainstream familiarity, popular appeal, and accessibility.

It’s the remaining portion of the portfolio where I want to focus for the rest of this blog.

The alternative or alt bucket is where advisors can select investments or asset managers to complement their primary portfolio components, ideally a holding that adds precious alpha. When it comes to the attributes of an ideal alt, beauty is in the eye of the beholder. However, as an institutional asset manager, below is what Blueprint Investment Partners looks for in building an ideal liquid alt:

Consistent, non-correlated returns: If equities are going to be the largest portfolio allocation, then the alt bucket must be comprised of something that complements, not mimics. We believe this is the best way to optimize performance and create a true all-weather portfolio. Although this attribute is particularly relevant during sustained equity drawdowns, when a non-correlated alt may add significant alpha, we take a broader view: We believe an ideal alt demonstrates consistent non-correlation to equities through all market cycles.

Massive global diversification: One of the best ways to achieve non-correlation is with diversification. But a narrow definition of diversification as a mix of stocks and bonds simply doesn’t cut it anymore, in our view. We look for a massively diversified, one-stop shop that can adapt to a variety of environments: inflationary, deflationary, equity bull markets, and everything in between. We think this requires a large investment universe that includes hundreds of markets across currency, commodity, fixed income, and equity macro asset classes. When combined with the ability to go both long and short, an alt strategy can evolve from fearing outlier events to exploiting them.

Positive skew: Skew may be a wonky statistical term, but its relevance when describing the attributes of an ideal liquid alternative strategy is simple and intuitive. Positive skew is when the possibility of good and bad outcomes shifts from equal probability to a scenario marked by lesser probability for negative outcomes and greater likelihood for positive results. In investing, one of the ways to create positive skew is to use a systematic investing process that can realize losses quickly while holding on to winning trades.

Repeatable, consistent investing rules: Knowing what to expect reduces uncertainty. A systematic investing process that follows pre-determined rules also maintains discipline by removing emotion from the decision-making process. We value this, and we know this also matters to financial advisors because it can help clients stay anchored to their financial plans and investments during times of prolonged market volatility.

Liquidity: We must be able to access our funds daily. Therefore, an ideal alt is one that has the same liquidity profile as other components of an overall portfolio.

Tax efficiency: An ideal alt works in both taxable and non-taxable accounts. For taxable accounts, since after-tax returns are the only ones clients get to keep, minimizing tax-time sticker shock is important in absolute terms and because of how clients negatively perceive capital gains. In our view, this requires a systematic investing process that can sell losing positions quickly while allowing gains to be held as long as possible, a process for ongoing tax-loss harvesting, or both.

The Victor Wembanyama of Alt Strategies?

Of course, designing an ideal liquid alt is not as simple as creating the perfect basketball player on a video game console, where you can quickly generate someone who’s above seven feet tall, proficient at the offensive trifecta (shoot, pass, and handle the ball), and a vicious rim protector on the defensive side. (If it sounds like I just created the avatar version of Victor Wembanyama, you’re not wrong.)

However, we think there are some reasonable options available to financial advisors today, strategies that meet most or all of our criteria above.