Liquid Alternative Mutual Funds: An Asset Class that Expands Opportunities for Diversification

Abstract

Contrary to the widely held misconception that alternative mutual funds use derivatives to take on significant risk in the search for outsized returns, the empirical evidence suggests that these funds do not subject investors to undue risk, and have important diversification benefits that can make them a highly beneficial tool for the average investor. These funds enable investors to construct diversified portfolios that either reduce the level of risk for a given level of return, or increase returns at the same level of risk, or both, and they have enabled ordinary investors to access an important, diversified asset class that had previously available only to high net worth individuals and institutional investors. To the extent that investors are heavily concentrated in equities, LAMFs can preserve expected returns at meaningfully lower risk levels.

Keywords: Liquid alternative mutual funds, diversification, derivatives

JEL Classification: G11, G18, G28, G29