Liquid alternatives explained: Your top questions, answered

min read

January 29, 2026

In early 2019, regulatory changes allowed Canadian investors access to alternative mutual funds also known as liquid alternative investments. You may have heard the term “liquid alternatives,” but if you thought it sounded complicated, you’re not alone. Some investors are still unsure about what these investments are and how they work.

We’re breaking it down to answer some frequently asked questions.

What is a liquid alternative?

Short answer: A liquid alternative is an investment that uses hedge fund-type strategies like short-selling or the use of derivatives to target different outcomes.

Long answer: Liquid alternatives, or alternative mutual funds, combine the best of both worlds: the flexibility of hedge fund strategies but with the liquidity and guardrails of a mutual fund. They’re offered in a “liquid structure” like a mutual fund or ETF, making them more accessible. Popular liquid alternative strategies include long/short, market neutral and global macro, to name a few.

Why should I consider adding liquid alternatives to my portfolio?

Short answer: They give your portfolio a few extra ways to navigate different market conditions.

Long answer: Liquid alternatives use different tools and techniques compared to traditional equity (stock) or fixed income (bond) investments, offering new strategies to help manage risk or look for returns in different market conditions.

What is a long/short strategy?

Short answer: It’s like playing offense and defense.

Long answer: Long/short strategies can look a bit different from fund to fund. Generally speaking, portfolio managers take long positions (buy) stocks that they believe are undervalued with the potential to go up, and short positions (sell) stocks that they believe are overvalued, expecting they might fall. By doing both at the same time, they’re aiming to find more opportunities to achieve returns and reduce volatility.

How do managers pick “long” and “short” positions?

Short answer: It depends on the strategy, but for active managers, it’s through research, which is a mix of data-driven insight and strategic judgment.

Long answer: Portfolio managers look closely at how companies are doing, how much their stocks are worth and what’s happening in the markets. They use this information to decide which stocks to buy and which ones to sell. They look for companies with solid growth potential or ones they believe are undervalued for long positions and identify overvalued or vulnerable businesses for short positions.

How do liquid alternatives perform in market downturns?

Short answer: Historically, alternative strategies tend to lose less during big market downturns, but past performance isn’t a guarantee of future results.

Long answer: Liquid alternatives can help cushion your portfolio from big drops by adding another layer of diversification beyond traditional stocks and bonds. They don’t eliminate losses entirely and outcomes depend on many factors, but when used strategically, liquid alternatives can act as a third pillar in your portfolio to help balance out traditional investments.

What should I know before investing in liquid alternatives?

Short answer: Consider your investment goals, risk tolerance and fees.

Long answer: Look for a manager with a proven track record and take time to understand the strategy, its potential role in your portfolio, and the associated risks and costs. Speak to your financial advisor to make an informed decision.

Liquid alternative funds aren’t just for Bay Street anymore; they’re for average investors who want a smart diversification option in their portfolio.