Key Takeaways
- • Liquid alternatives posted positive net fund flows in Q3 2023 per Morningstar's Liquid Alternatives Observer, but the market was bifurcated: every uncorrelated Morningstar Category saw outflows, while nontraditional equity strategies, which posted negative returns, drew the largest inflows.
- • Hedged equity strategies in the options-trading and derivative-income categories attracted over $8 billion in the quarter as investors sought income and lower volatility amid weak bonds and uncertain markets.
- • J.P. Morgan dominates the options-based categories with a market share above 15%, up from outside the top 10 seven years earlier.
- • AQR Capital, which held a market share above 24% in June 2016, rebuilt its lineup and had six of the seven top-performing liquid alternatives strategies in Q3 2023.
- • Event-driven funds saw the greatest outflows among nontraditional categories as SPAC issuance stalled since 2021, while convertible bond issuance showed signs of recovery in 2023.
Summary
Morningstar's quarterly Liquid Alternatives Observer reports that net fund flows into liquid alternatives were positive in the third quarter of 2023, but the marketplace was sharply bifurcated. With equities and bonds both negative for the quarter, every liquid alternatives category turned positive and several individual strategies posted double-digit gains. Nontraditional equity categories, which carry higher equity and bond sensitivity, posted negative returns. Despite that performance, every Morningstar Category representing uncorrelated strategies saw outflows, while nontraditional equity strategies were the largest recipients of new capital.
The macro backdrop was negative. Central banks' signaling of higher-for-longer interest rates pushed the U.S. 10-year note to its highest level since 2007. The hawkish Federal Reserve tone drove the U.S. dollar higher against major currencies, particularly the Japanese yen. Troubles in China's property sector prompted an interest-rate cut. Event-driven funds saw some improvement after a muted year for deal flow, though SPAC issuance has been minimal since 2021, and event-driven managers recorded the greatest outflows in the quarter. Convertible bond issuance has increased during 2023, and according to the report, the rise in the VIX weighed on options pricing.
Directional equity strategies struggled after the first-half stock rally challenged managers with material short positions, many of which were unwound quickly early in the quarter. Systematic-trend and macro managers recovered first-half losses from net short fixed income exposures. Trend-followers benefited from short positions in carbon emissions and European power contracts, and commodity-capable strategies gained from soft commodities such as sugar and cocoa. Those expanding into emerging-markets currencies gave back some gains.
Investors increasingly turned to options-based strategies for more certainty. Hedged equity strategies in the options-trading and derivative-income categories attracted over $8 billion in the quarter. Yield-focused investors sought income from derivatives rather than bonds, while others reduced equity exposure; the options-trading category reportedly holds equity sensitivity of around 45% of the market.
J.P. Morgan is the primary beneficiary of this shift, dominating both options-based categories with a market share above 15%, according to Morningstar. Seven years ago the firm was not among the top 10 alternatives mutual fund providers. AQR Capital, which held a market share above 24% in June 2016, has regained momentum after well-publicized struggles. Morningstar says its revamped personnel and product lineup produced six of the seven top performers in the third quarter, with almost all strategies showing double-digit three-year annualized returns. Morningstar cautions that options strategies involve more complex valuation and may not deliver the smooth return profile investors anticipate.
The macro backdrop was negative. Central banks' signaling of higher-for-longer interest rates pushed the U.S. 10-year note to its highest level since 2007. The hawkish Federal Reserve tone drove the U.S. dollar higher against major currencies, particularly the Japanese yen. Troubles in China's property sector prompted an interest-rate cut. Event-driven funds saw some improvement after a muted year for deal flow, though SPAC issuance has been minimal since 2021, and event-driven managers recorded the greatest outflows in the quarter. Convertible bond issuance has increased during 2023, and according to the report, the rise in the VIX weighed on options pricing.
Directional equity strategies struggled after the first-half stock rally challenged managers with material short positions, many of which were unwound quickly early in the quarter. Systematic-trend and macro managers recovered first-half losses from net short fixed income exposures. Trend-followers benefited from short positions in carbon emissions and European power contracts, and commodity-capable strategies gained from soft commodities such as sugar and cocoa. Those expanding into emerging-markets currencies gave back some gains.
Investors increasingly turned to options-based strategies for more certainty. Hedged equity strategies in the options-trading and derivative-income categories attracted over $8 billion in the quarter. Yield-focused investors sought income from derivatives rather than bonds, while others reduced equity exposure; the options-trading category reportedly holds equity sensitivity of around 45% of the market.
J.P. Morgan is the primary beneficiary of this shift, dominating both options-based categories with a market share above 15%, according to Morningstar. Seven years ago the firm was not among the top 10 alternatives mutual fund providers. AQR Capital, which held a market share above 24% in June 2016, has regained momentum after well-publicized struggles. Morningstar says its revamped personnel and product lineup produced six of the seven top performers in the third quarter, with almost all strategies showing double-digit three-year annualized returns. Morningstar cautions that options strategies involve more complex valuation and may not deliver the smooth return profile investors anticipate.
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