Even as their popularity grows, liquid alts are still largely the purview of financial advisors, noted Brandon Thomas, chief investment officer of Envestnet's investment management program for financial advisors. According to a Morningstar and Barron's survey of advisors from 2015, almost 66 percent said they expected to allocate more than 11 percent to alternatives; just 39 percent had said the same in 2013.
Liquid alts is a broad category that includes several strategies, such as managed futures, market neutral, multicurrency, multi-asset and long/short equity.
Most advisors use liquid alts as ballast during falling markets because they invest in nontraditional assets that aren't correlated with stocks or bonds. Thomas recommends that advisors use them "as an all-season allocation."
Predicting when markets are likely to fall and inserting an alternative is too hard. For investors who simply want to hedge risk, Thomas recommends multi-asset funds that provide exposure to the different types of alternatives.
To gain the greatest benefit from the asset classes, investment experts recommend a "meaningful" allocation of 5 percent to 10 percent; otherwise, the impact won't be felt. But some, such as Thomas of Envestnet, believe advisors should consider higher amounts, as much as 25 percent.
"If you only have 5 [percent] to 10 percent, it may look like diversification, but it's not really doing much to mitigate risk," Thomas said. "But if you allocate too much, your overall portfolio tends to get away from market returns."
Duncan Wilkinson, CEO of AlphaSimplex, a lineup of liquid alternative funds, believes that investors nearing retirement have the most to gain from liquid alternatives. They're the most sensitive to risk and need to protect their portfolios against the downside.