While hedge funds have traditionally catered to institutional and high-net-worth investors, liquid alternatives have emerged as a growing segment that brings hedge fund-like strategies into more accessible vehicles such as UCITS. This relatively new space, which began taking shape in the early 2010s, has seen a notable rise in both quality and investor interest in recent years.

Early Days of Liquid Alternatives

“The liquid alternatives space really began to take shape in the early 2010s. At the outset, there were only a handful of funds attempting to gain access through the UCITS framework, and the overall quality at the time was quite low,” recalls Fredrik Langenskiöld, Senior Investment Specialist for Alternative Investment Solutions (AIS) at UBP. Over the years, however, Langenskiöld has seen a notable improvement in both fund quality and manager sophistication. “Many managers – primarily from the U.S., but also from Europe – came to realize that launching a UCITS vehicle was essential to access the European investor base.”

“There are thousands of hedge funds out there, but if you narrow it down to the top 3-5 percent – those we believe are truly worth allocating to – you’re probably looking at just 100 to 150 funds. The key, as always, is identifying them. And in the liquid alternatives space, it’s the same story.”

Fredrik Langenskiöld, Senior Investment Specialist for Alternative Investment Solutions (AIS) at UBP.

With the ability to replicate – and in some cases even improve upon – traditional hedge fund strategies within a UCITS framework, the quality of fund managers entering the liquid alternatives space has steadily increased. “We’ve seen a rise in higher-quality managers in this segment,” says Langenskiöld. “And that’s translated into better performance as well.” Still, he cautions that the average quality across the industry remains modest. “There are thousands of hedge funds out there, but if you narrow it down to the top 3-5 percent – those we believe are truly worth allocating to – you’re probably looking at just 100 to 150 funds,” he notes. “The key, as always, is identifying them. And in the liquid alternatives space, it’s the same story.”

Looking across the broader universe of liquid alternatives, performance has notably improved in part due to a shifting market environment. “The market landscape has changed significantly since the post-Covid period,” explains Langenskiöld. “We’re seeing higher interest rates, increased volatility, greater dispersion across asset classes and securities, and diverging central bank policies, all of which impact currency, fixed income and other markets.” According to him, this environment tends to favour hedge fund strategies. “Strategies such as fixed income relative value, commodities, macro, systematic, and multi-strategies have all seen improved performance as a result.”

Investor Interest in Liquid Alternatives: A Global Trend

After attending a recent conference of institutional investors in Stockholm, Langenskiöld observed that while private markets have long attracted investor interest, hedge funds are once again gaining attention. “Liquid alternatives – including hedge funds and alternative UCITS – have become more of a trend in just the past two to three years,” he notes. “And that’s not unique to the Nordics; it’s a development we’re seeing across the board.”

“Liquid alternatives – including hedge funds and alternative UCITS – have become more of a trend in just the past two to three years. And that’s not unique to the Nordics; it’s a development we’re seeing across the board.”

Fredrik Langenskiöld, Senior Investment Specialist for Alternative Investment Solutions (AIS) at UBP.

As a pure-play wealth and asset manager headquartered in Geneva, Union Bancaire Privée (UBP) has a strong grasp of investor behavior, particularly within the wealth management segment. “The Nordics have always been an important region for hedge funds on the wealth management side,” says Langenskiöld. He notes that investors in the region are increasingly looking to formalize their approach and build strategic allocations to hedge funds. “Some are focused on selecting individual funds, while others are aiming for broader exposure and larger portfolio allocations. There’s definitely growing interest in understanding what hedge fund strategies can add to a traditional portfolio and which types of strategies are most relevant to include.”

Key Roles: Alternatives to Fixed Income, Diversifiers, and Equity Exposure

UBP categorizes hedge fund strategies into three key roles: as alternatives to fixed income, as diversifiers, and as asymmetric equity exposures. “The first category, alternatives to fixed income, is aimed at generating returns comparable to fixed income,” explains Langenskiöld. “These strategies may offer slightly higher or lower returns depending on the segment you’re comparing them to, but with relatively low volatility and return sources that are not necessarily correlated with traditional fixed-income markets,” he elaborates. This represents the more conservative end of the hedge fund spectrum, with a strong focus on diversification.

The second category is diversifiers. “Diversifiers are strategies with no correlation to equities or fixed income,” explains Langenskiöld. “This group includes systematic or macro-oriented strategies that typically aim for slightly higher returns and can even show negative correlation to both equities and bonds, particularly during market downturns.”

The third group comprises asymmetric equity strategies, usually in the form of long/short equity. “Some of these strategies have a degree of equity sensitivity, while others have less,” says Langenskiöld. “As a group, they carry some market beta. This isn’t the most sought-after category at the moment, as investors tend to prefer getting equity exposure through long-only allocations.” However, he notes a shift in dynamics. “We’re now seeing greater dispersion within equities, which improves the risk-reward profile of these strategies. While demand hasn’t picked up just yet, that could change going forward.”

Making Hedge Fund Strategies Understandable

Categorizing hedge fund strategies into distinct role-based groups can help simplify the investment process for allocators and investors, especially given the inherent complexity of many hedge fund strategies. “The challenge is that we’re dealing with fund selectors – whether on the wealth management distribution side or the institutional side – who often need to explain these strategies to clients or to investment boards,” says Langenskiöld. “Some of the strategies can seem more abstract or less tangible than, say, buying a building,” he admits. “While they offer clear diversification benefits, clients are sometimes hesitant because they want to be able to clearly articulate what they’re investing in.”

That’s where the responsibility of fund promoters comes in, he adds. “Our role is to provide clear, transparent explanations so clients understand both what they’re invested in and the reasons behind a fund’s performance, whether positive or negative. Communication and transparency are key.”

“Our role is to provide clear, transparent explanations so clients understand both what they’re invested in and the reasons behind a fund’s performance, whether positive or negative. Communication and transparency are key.”

Fredrik Langenskiöld, Senior Investment Specialist for Alternative Investment Solutions (AIS) at UBP.

With decades of experience in hedge fund selection and Langenskiöld having spent 20 years at UBP, the firm has made it a priority to streamline the investment process for its clients. UBP leverages an in-house developed tool that generates detailed reports on the role a specific hedge fund, or a portfolio of hedge funds, can play within a larger investment portfolio. “If clients are comfortable sharing their holdings or providing a list of the funds they currently have, we can input this data into our system,” explains Langenskiöld. “This allows us to produce a report that offers valuable insights into the underlying characteristics of the portfolio and how the strategies fit together.”

Langenskiöld explains that sometimes investors believe they’re diversified simply because they have a variety of line items in their portfolio. “However, when you dig deeper and examine the underlying factor risks, you may find that you’re far more concentrated than you initially thought,” he notes. “The purpose of this tool is to identify sensitivities to different asset classes, to reveal how concentrated these risks are at a granular level, and to assess the correlations between investments in stress scenarios,” he elaborates. “It’s during these times of market stress that true diversification becomes crucial.” Liquid alternatives, he notes, can play an important role in achieving that diversification.

This article is part of HedgeNordic’s “Nordic Hedge Fund Industry Report.”