Liquid Alts

A HEDGE FUND MIGHT allow you to cash out just once a month or once every three months. By contrast, mutual funds provide daily liquidity, meaning you can get out at the end of any day that the market is open, while ETFs can be bought and sold throughout the trading day. For that reason, mutual funds and ETFs that pursue hedge-fund-like strategies are sometimes referred to as liquid alternatives or simply “liquid alts.” What sorts of funds are available? Here is a sampler:

• Long-short funds, such as Diamond Hill Long-Short Fund, which go long some stocks in the hope they will rise, while shorting others in a bet they’ll fall. Long-short funds typically have more invested in long positions than in their short positions, while market neutral funds maintain equal-size long and short bets.
• Managed futures funds such as WisdomTree Managed Futures Strategy Fund, an ETF that aims to generate positive returns that are uncorrelated to the financial markets. The ETF buys a mix of currency, commodity and Treasury bond derivatives.
• Merger arbitrage funds, like Arbitrage Fund and Merger Fund, which aim to make money by betting that mergers and acquisitions will be successfully completed.

Keep three caveats in mind. First, some liquid alt funds have steep annual expenses. Second, the strategies involved can generate big annual tax bills, so the funds are best held in a retirement account. Third, these funds all represent a bet on active management—a bet that historically hasn’t panned out.

Our Humble Opinion: You should never buy a fund unless you fully understand its strategy. If you don’t, there’s a risk you’ll suffer an unpleasant surprise—and end up selling out, possibly at the worst possible time. That’s why we think most investors should stick with easy-to-understand alternative investments, such as funds that focus on gold shares and real estate stocks.

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