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Alternatives and liquidity

Key takeaways

  • Alternative investments provide additional investment opportunities to potentially grow and manage your money.
  • Liquidity is an important factor when considering alternatives.
  • Alternatives can be liquid, semi-liquid, or illiquid.

Alternative investments can complement traditional investments by offering additional opportunities for you to choose from. And there’s a wide variety of alternative assets. If you are curious about alternatives, it can help to explore them by being familiar with the different types of alternatives and their unique features—including differences in liquidity.

What are alternatives?

You may see alternative investments referred to as “alternatives” or “alts.” These are investments that do not fall into traditional investment categories (e.g., stocks, bonds, and cash). Alternative investments can include private equity, private credit, real assets, digital assets, and liquid alternatives.

According to the Chartered Alternative Investment Analyst Association (CAIA), alternative investments total $22 trillion in assets under management, which is roughly 15% of global assets under management, as of September 2024.

Liquidity and alternatives

Alternatives may help diversify your investment mix, potentially enhance returns, generate income, and/or help manage risk. These potential benefits are driven by each alternative investment's strategy and understanding their liquidity is an important consideration.

Liquidity refers to how easy it is to buy and sell something. With alternatives, liquidity is of particular importance to understand, as different types may offer varying levels of liquidity. These levels can be viewed on a spectrum—liquid, intermittently liquid (or semi-liquid), and illiquid.

Understanding some of the potential pros and cons to each level of liquidity is important as you get started with alternative investing. The chart below illustrates a high-level spectrum of some different alternative investments and how much liquidity they provide to investors.

The chart is described in the text above the chart
Sources: Fidelity Investments, Cerulli Associates—U.S. Alternative Investments 2024: Delivering Alternative Capabilities to Retail Investors, as of August 30, 2024. For illustrative purposes only.

Highly liquid investments, such as a stock or ETF, tends to trade frequently. Essentially, that means it’s generally easy to sell to turn into cash. Mutual funds are also highly liquid as investors can buy or redeem shares daily.

Semi-liquid and illiquid investments require investors to be comfortable with less, or no, liquidity to access their initial investment over some period of time. But investors may benefit from the ability to invest in private markets (where investor money may not need to be returned on demand and strategies can be pursued that can help enhance returns or income).

Of course, liquid, semi-liquid, and illiquid alternative investments come with risks. For example, the use of derivatives and complex trading strategies in liquid alternatives, such as short selling, may increase the risk of loss or volatility. Illiquid or semi-liquid private market alternatives may have investor restrictions on liquidity, employ leverage, and have unique risks associated with each investment strategy. Semi-liquid and illiquid alternatives also carry opportunity risk because they cannot easily be liquidated to take advantage of other opportunities that may arise. However, this risk may be accompanied by the potential for higher returns. 

Let’s further explore the liquidity spectrum so that you can gain a stronger understanding of why it’s so important when considering alternative investments.

Liquid alternatives

Liquid alternatives invest in securities that primarily trade in public markets. What puts the “alternative” in liquid alternatives? Unlike traditional "buy and hold" strategies, liquid alternatives usually have the flexibility to take both long and short positions (short positions seek to benefit from declining asset values). You can find liquid alternative investments across different strategies. Liquid alternatives can generally be bought or sold relatively easily and you can more readily see their price and other relevant information. 

Examples of liquid alternative investments include digital assets and liquid alternative funds. Liquid alternative fund strategies include hedged equity, relative value, event driven, global macro, market neutral, and convertible arbitrage.

For liquid alternative funds, their liquidity is driven by the liquidity at the fund level (i.e., the ability to buy or sell the fund) as well as the liquidity of assets held by the fund. They are typically structured like mutual funds or ETFs, and in most cases, they can be bought and sold like these types of funds.

Intermittent liquidity alternatives

For those who may not need daily access to an alternative investment, semi-liquid (or intermittently liquid) alternatives exist. Intermittent liquidity alternatives may offer limited opportunities to access part of your investment at certain times and can help deliver the ability to access both public and private markets (such as private credit or private real estate), while still seeking to provide investors with regular liquidity.

How do they work? Intermittent liquidity alternatives may allow you to redeem a portion of your investment, often known as “tender windows” or “repurchase offers.” Investors can typically sell their shares back to the fund periodically, on a specified redemption schedule and at specified intervals. Examples of commonly known intermittent liquidity alternatives are interval funds, tender offer funds, and unlisted business development companies (BDCs).

Intermittent liquidity alternatives can help investors access private markets, while still offering more frequent liquidity compared with illiquid alternatives (albeit not daily).

Illiquid alternatives

On the other end of the liquidity spectrum, illiquid alts generally do not offer frequent pricing and public transparency.

While liquid alternative funds may use alternative strategies to invest in public investments (e.g., stocks and bonds), illiquid alternatives typically invest in assets solely through private markets. Private equity and private credit are 2 strategies frequently offered via illiquid alternatives.

Why would investors consider illiquid alternatives if they limit their ability to access their investment? Historically, illiquid alts have produced superior returns or income compared with traditional investments (see chart below).

The chart is described in the text above the chart
Past performance is no guarantee of future results. Traditional asset categories: US large-cap equity—Russell 1000 Index; US small-cap equity— Russell 2000 Index; developed-market equity—MSCI EAFE Index; emerging-market equity—MSCI Emerging-Market Index; Treasuries—Bloomberg US Long Treasury Index; Treasury inflation-protected securities—Bloomberg US Treasury Inflation Linked Bond Index; US Investment-Grade Bonds—Bloomberg US Credit Index; high-yield bonds—ICE BofA US High-Yield Index; REITs—FTSE NAREIT All Equity REIT Index. Alternative categories: liquid alternatives—HFRI Macro Total Index and HFRI EH Equity Market-Neutral Index; managed futures: SG CTA Index (note, there may be managed futures strategies in both the HFR and SG indexes); private equity—equity-generalist, buyout, and venture capital reflect annual return data from MSCI Private Assets; private credit—direct senior+mezz lending, and distressed debt reflect annual return data from MSCI Private Assets; real assets—private real estate represented by the NFI-ODCE Index. MSCI Private Assets data used in this research reflects returns of US private capital funds and funds of funds. See footnotes for index/asset category details. Equity generalists pursue strategies using various investment objectives, which compares with specialists who utilize more narrow strategies. Sources: Bloomberg Finance L.P., HFR Inc., www.HFR.com, © 2024 HFR, Inc. All rights reserved, Morningstar, MSCI Private Assets, Societe Generale, NCREIF, Fidelity Investments, as of Dec. 31, 2023.

Illiquidity can allow for more time to execute on an investing strategy, pursue investment opportunities, influence a company's management and operations, and to exit an investment on more favorable terms.

However, as you might expect, past performance is no guarantee of future results, and higher returns may be accompanied by higher risk. Moreover, illiquid alternatives are generally not able to be converted to cash quickly if the need arises or may require a significant fee to do so. This is often referred to as a “lock-up period,” during which time the investment cannot be sold, often for a period of many years. In many cases, illiquid funds can only distribute returns to investors if and when the fund successfully sells one or more of its underlying investments.

It is important to note that some of these investments may only be available to investors who meet certain net worth, asset, and/or income minimums.

Are alternatives right for you?

It is important for you to consider an alternative's liquidity and risks before investing. Liquid, intermittently liquid, and illiquid alternatives feature different potential benefits and risks. If you are thinking about investing in alts, you should carefully weigh the differences. The degree of liquidity may help you make an investment decision.

And to be sure, there is much more to understand about alternatives than liquidity. Moreover, the decision whether to include alts in your mix of investments should come down to your goals, comfort with risk, time horizon, tax situation, and liquidity needs, among any other factors specific to your situation. While investing involves risk, including the risk of loss, and past performance is no guarantee of future results, new developments in the world of alts are making it more possible than ever before to achieve your investing goals using non-traditional investments.

Explore alternative investments

Expand beyond stocks, bonds, and cash.

More to explore

Investing involves risk, including risk of loss. Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Indexes are unmanaged. It is not possible to invest directly in an index.

Index definitions: Bloomberg U.S. Credit Index is a market value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. Bloomberg U.S. Long Treasury Index measures the performance of U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury with a maturity greater than 10 years. Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) Index (Series-L) is a market value-weighted index that measures the performance of inflation-protected securities issued by the U.S. Treasury. NFI-ODCE Index (NCREIF), short for NCREIF Fund Index Open End Diversified Core Equity, is an index of investment returns reporting on both a historical and current basis the results of 38 open end commingled private real estate funds pursuing a core investment strategy, some of which have performance histories dating back to the 1970s. ICE BofA U.S. High Yield Index is a market capitalization-weighted index of U.S. dollar-denominated, belowinvestment- grade corporate debt publicly issued in the U.S. market. The FTSE NAREIT All Equity REITs Index is a free-float-adjusted, market capitalization-weighted index of U.S. equity REITs. Constituents of the index include all tax-qualified REITs with more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property. HFRI Macro Total Index: Investment managers who trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency, and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top-down and bottom-up theses, quantitative and fundamental approaches, and long and short-term holding periods. Although some strategies employ relative value techniques, macro strategies are distinct from relative value strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposed to equity hedge, in which the fundamental characteristics on the company are the most significant and integral to investment thesis. In order to be considered for inclusion in the HFRI Monthly Indices, a hedge fund manager must submit a complete set of information to the HFR Database. Additionally, all HFRI constituents are required to report in U.S. dollars monthly, net of all fees, performance and assets under management. Constituent funds must have either $50 million assets under management or at least $10 million USD assets under management on the last reported month prior to the index rebalance and have been actively trading for at least 12 months. HFRI EH Equity Market Neutral Index: Equity market-neutral strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between select securities for purchase and sale. These can include both factor-based and statistical arbitrage/trading strategies. Factor-based investment strategies include strategies in which the investment thesis is predicated on the systematic analysis of common relationships between securities. In many but not all cases, portfolios are constructed to be neutral to one or multiple variables, such as broader equity markets in dollar or beta terms, and leverage is frequently employed to enhance the return profile of the positions identified. Statistical arbitrage/trading strategies consist of strategies in which the investment thesis is predicated on exploiting pricing anomalies that may occur as a function of expected mean reversion inherent in security prices; high-frequency techniques may be employed and trading strategies may also be employed on the basis of technical analysis or opportunistically to exploit new information the investment manager believes has not been fully, completely, or accurately discounted into current security prices. Equity market-neutral strategies typically maintain characteristic net equity market exposure no greater than 10% long or short. SG CTA Index is designed to track the largest 20 (by AUM) CTAs and be representative of the managed futures space. Managers must be open to new investment and report returns on a daily basis. The CTA Index is equally weighted, and rebalanced and reconstituted annually. The MSCI Europe, Australasia, Far East Index (EAFE) is a market capitalization-weighted index designed to measure the investable equity market performance for global investors in developed markets, excluding the United States and Canada. MSCI Emerging-Markets (EM) Index is a market capitalization-weighted index designed to measure the investable equity market performance for global investors in emerging markets. The Russell 1000 Index is a market capitalization-weighted index designed to measure the performance of the large cap segment of the U.S. equity market. The Russell 2000 Index is a market capitalization-weighted index designed to measure the performance of the small cap segment of the U.S. equity market. It includes approximately 2,000 of the smallest securities in the Russell 3000 Index. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice, and you are encouraged to consult your own lawyer, accountant, or other professional advisor before making any financial decision.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for investments that focus on a single country or region.

Alternative investment strategies may not be suitable for all investors and are not intended to be a complete investment program. Alternatives may be relatively illiquid; it may be difficult to determine the current market value of the asset; and there may be limited historical risk and return data. Costs of purchase and sale may be relatively high. A high degree of investment analysis may be required before investing. Commodity interest trading involves substantial risk of loss. Investing in digital assets, such as bitcoin, is speculative and may involve a high degree of risk. Digital assets can become illiquid at any time and are only for those investors willing to risk losing some or all their investment and who have the experience and ability to evaluate the risks and merits of an investment in bitcoin.

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