Navigating liquid alternative investment strategies
E*TRADE Securities
08/16/22Summary: Learn about some common alternative-type investment strategies that may help investors diversify portfolios, manage risk, and enhance returns.

Liquid alternatives funds, commonly called liquid alts, were designed to offer exposure to hedge fund–style investment strategies in a more retail accessible, exchange-traded fund (ETF) or mutual fund format. These funds are regulated by the Investment Company Act of 1940 (’40 Act) and must adhere to certain liquidity requirements, meaning shares can be traded on a daily basis.
Traditional ETFs and mutual funds typically use a “long-only” investment strategy, with the goal of matching or outperforming specific market benchmarks over time. Liquid alternative funds, on the other hand, employ a wide array of strategies intended to deliver returns or hedge risk regardless of broader market conditions. Additionally, some alternative funds track commodities such as metals, energy, or agricultural products, as well as digital assets.
Not all liquid alternatives work in the same way. Some use strategies designed to behave distinctly different from the markets. Others take on non-traditional risks to offer diversified sources of potential return. Still others attempt to benefit from rising and falling markets as opportunities arise. These strategies can be particularly valuable during periods of heightened volatility and market downturns—although they come with unique risks to consider.
For investors interested in navigating the world of liquid alts, we break down some common strategies.
Risks to consider
While these alternative-style strategies may help investors diversify sources of potential risk and return, it’s important to understand they may ultimately lag or underperform the broad market. Key risks to consider include:
- Liquidity. Liquid alternative funds are required by law to provide daily liquidity. However, during periods of extreme market stress, there have been instances where investors were not able to immediately redeem their shares.
- Complexity. These strategies can be complex, tapping into the most complicated financial instruments. It’s not always clear how funds may perform in different market environments and over various periods of time.
- Leverage. Leverage—borrowing capital to increase the value of a fund’s underlying portfolio—is a common feature in liquid alternative investment strategies. Often, funds use leverage in an attempt to amplify returns, but it can also result in outsized losses.
- Fees. High fees diminish investors’ returns and help explain the disappointing performance of some strategies. According to Morningstar's US fee study, investors paid an asset-weighted fee of 1.31% for alternative funds in 2019, double the 0.66% average cost of all US-based actively managed funds.1
Before you invest
Take time to read a fund’s prospectus and make sure you understand its investment objectives. For example, does it aim to diversify risk and preserve capital, or to generate income? How has the fund or the category of funds performed historically? What are the fees? And what might you expect in the case of a bull, bear, or volatile market?
Answers to these questions can help you determine whether liquid alternatives are suited for your goals, risk tolerance, and investment timeline.
- Morningstar, “2021 Global Liquid Alternatives Landscape,” July 2021
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