As a Portfolio Strategist reviewing hundreds of advisor portfolios nationwide, I frequently discuss the role of Alternatives. The most common are actively managed, liquid “alt” funds, often used to reduce drawdowns, volatility, and correlation—ultimately aiming to improve risk-adjusted returns. While these benefits are possible, not all alternative sub-asset classes deliver them equally. This article highlights the characteristics of the most common liquid alternatives and their impact at the portfolio level.

The most common categories of liquid Alternatives I see in portfolios are Multi-Strategy, Hedged Equity, Managed Futures, Event-Driven, Long/Short Equity, and Equity Market Neutral.

• Multi-Strategy combines multiple alternative investment strategies within a single vehicle. The goal is to diversify risk and enhance returns by dynamically allocating capital across strategies such as Long/Short Equity, Event-Driven, and Merger Arbitrage.
• Hedged Equity invests primarily in equities while using derivatives or short positions to hedge market risk. They aim to participate in equity market upside while limiting downside exposure. Most commonly, these strategies take long positions in high-conviction equity picks based on fundamental, quantitative, or technical analysis – coupling this with index hedging. Index hedging aims to reduce systematic risk (offset Beta of long positions) by taking a short position in a broad market index, such as the S&P 500.
• Managed Futures uses futures contracts to take long and short positions across asset classes like commodities, currencies, equities, and interest rates. They often follow trend-following or systematic trading models. Trend-following is the most common approach, which identifies persistent price movements over time.
• Event-Driven seeks to capitalize on specific corporate events or market dislocations. These strategies are typically opportunistic, aiming to exploit pricing inefficiencies that arise before, during, or after events. These include mergers and acquisitions (M&A), bankruptcies, restructurings, spin-offs, tender offers, and other special situations. Managers analyze the likelihood, timing, and impact of these events on asset prices. A common example of this is taking long and short positions to exploit mispricings between related securities (e.g., acquirer vs. target in a merger).
• Long/Short Equity takes long positions in stocks expected to rise and short positions in those expected to fall. Strategies are typically net long and possess meaningful market risk. Performance drivers for this type of strategy are primarily Beta exposure, followed by Alpha generation from security selection on long positions. Short Alpha is relatively rare, as it is more difficult to generate than long Alpha.
• Equity Market Neutral aims to eliminate market risk by balancing long and short positions to achieve a net-zero market exposure (zero Beta). Returns are driven by security selection rather than market direction. Market Neutral strategies have the objective of generating absolute returns regardless of market direction and achieving low correlation to Equity markets by neutralizing systematic risk.

Any of these strategies can be a suitable addition to your client's portfolio, but it depends on the client's goals and funding sources. Multi-Strategy funds are ideal for clients seeking broad diversification and smoother return profiles, as they allocate across multiple hedge fund styles to reduce single-strategy risk. These strategies are often suited for clients who are unsure or timid about Alternative investments. Hedged Equity strategies are best suited for clients who want to participate in market appreciation but struggle to handle market volatility and drawdown. Managed futures are valuable for their crisis alpha potential and low correlation to traditional assets, making them effective as portfolio diversifiers during market stress. These strategies target low to mid-single-digit returns. Event-driven strategies are best used to capture idiosyncratic opportunities around corporate actions, offering return potential that is less dependent on market direction. These strategies also target low to mid-single-digit returns. Long/short equity strategies are appropriate for clients seeking enhanced Alpha through active stock selection while managing market exposure. These strategies possess Beta and should be utilized as such. Equity Market Neutral strategies are well-suited for investors aiming for absolute returns with minimal market risk, particularly in uncertain or range-bound markets. These strategies can meaningfully reduce portfolio correlations, drawdowns, and volatility due to their lack of systematic risk.

Jared M. Orr, CFP® is a Portfolio Strategist at an asset management company.

Editor: Greg Filbeck, CFA, FRM, CAIA, CIPM, PRM, Samuel P. Black III, Professor of Finance & Risk Management, Penn State Erie, mgf11@psu.edu.