Narrow to broad focus

Liquid alternative funds come in many different varieties. As the Canadian liquid alternatives market expands, it will be important for investors, advisors, industry organizations and regulatory agencies to properly distinguish among the various approaches. The area of focus and type of strategy utilized will be the key determinants that drive the different behaviours and different outcomes among these funds. 

By way of broad categorization, we can think of liquid alternative funds as taking the following forms:

  • Alternative equity funds

    Use alternative strategies primarily within the equity universe. These will most typically be long-short funds that focus on enhanced alpha generation (from long and short trades) and can be structured with total exposure to the underlying equity market (or beta) ranging from one (full underlying market exposure) to zero (market neutral). They can also include leveraged exposures to various broad equity markets, sectors, or styles, both long and short. The type of leverage used in these funds would include short selling and/or the use of futures. 

  • Alternative credit funds

    Use alternative strategies primarily within the fixed income universe. These can take the form of long and/or short exposure to individual bonds and/or to various sectors of the bond market, for example, government bonds, high-yield bonds and loans across many global markets. They will employ varying degrees of leverage to deliver their investment objectives and can be structured with varying amounts of interest rate or credit market beta. These strategies would employ leverage via short selling and/or the use of futures.

  • Global macro funds

    These funds typically invest globally across a wide range of traditional and non-traditional asset classes to benefit from regional and global macroeconomic developments. Asset exposure typically includes commodities and broad equity, bond and currency market exposures across a wide range of developed and developing markets. They can take long and short positions in any liquid asset class, and can, therefore, benefit from rising and/or falling price trends and/or divergence or convergence in prices of two related instruments. Within these types of funds, the primary form of leverage would be the use of derivatives, such as market futures, in which only a small amount of capital is required to obtain a much larger amount of risk exposure.

  • Multi-strategy funds

    These funds are typically a combination of two or more of the above noted groupings.

  • Miscellaneous alternative funds

    This is a catch-all that contains all strategies that don’t fit into the above categorizations. They will include niche, single-asset-class strategies that employ leverage and/or shorting in specific areas of the market, such as specific commodities, currencies, and other asset classes not captured above. In addition, these funds may use non-traditional or alternative assets to deliver their objectives without using leverage or short selling. 

  • Market neutral funds

    These funds are a specific category of equity, credit, global macro or multi-strategy funds that are structured to have zero or close to zero broad market beta. That means their behaviour will be different from the broad direction of stock or bond markets, both during up and down markets. They strive to deliver a return that is not dependent on broad market direction, but unlike absolute return strategies, market neutral funds will have strict limits on the extent to which they can capitalize on broad market trends to deliver those returns.