Unraveling Liquid Alternatives

We investigate what drives the performance of liquid alternative mutual funds, and if they offer interesting investment opportunities. We define state space models, apply the Kalman filter, and introduce residualized risk factors to perform the best possible return based style analyses. We apply our model also on hedge fund indices to compare the performance of the different type of funds. We find that liquid alternatives do not offer alternative returns in general, as their returns can be explained by common risk factors. Proper implementation of trend rules in several asset classes is the key performance driver of the most successful liquid alternatives. Managed Futures, Market Neutral, and Non-traditional Bond funds offer diversification opportunities for traditional investors. We cannot draw a general conclusion about the relative performance of liquid alternatives to their hedge fund counterparts.