Alternatives rising


    Hedge funds are aligning with regulatory efforts and are seeking retail flows by moving into registered products. Investment strategists and advisers are seeking ‘alt’ exposure to guard against market downdrafts, as well as diversifying traditional asset classes, or help generate income streams.

    Asset managers are looking to fill a gap in investors’ needs while reversing the flows into passive products back into more actively managed alternative vehicles. But is the trend towards alternatives really living up to all the hype? First, let us examine the origin of the hype, then we can take a look at the most recent numbers to see if these products are evolving as expected.

    Prominent drivers of the alternative product market are the increasing use of fee-based or separately managed accounts and the trend toward outcome or solution-oriented investment strategies. Advisers and wealth managers are increasingly adopting fee-based or ‘wrap’ accounts that are often built using a fund-of-funds framework: a strategy is set in place based on investor goals and risk profiles, and then a portfolio of funds is constructed to deliver upon those goals. In this framework the mutual fund building blocks have specific roles to play, whether it is risk mitigation, alpha generation or income.

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    The traditional fund selection metrics of relative performance are not always the only, or best, approach to understanding which components will work best for building such products. Increasingly an absolute point of view has been adopted when we are trying to understand which fund will best perform the role it needs to play in an investment strategy. Using an absolute performance benchmark has helped fuel interest in alternative vehicles that may not always float to the top of a relative-return peer group.

    Achieving beneficial results does not mean alternatives have to become the primary allocation in an investment strategy. Builders of portfolios realise that seemingly small allocations – in the low double and high single-digit percentages – can generate meaningful benefits. With the retail distribution review in the UK and other transparency-oriented regulatory efforts across the globe, there is little doubt such fee-based and outcome-oriented strategies will continue to gain traction, and the demand for building blocks will follow suit. As advisers and investment strategists seek such products, fund manufacturers will certainly clamour to create them.

    Asset managers who cater to the retail market are well aware of these trends and have largely embraced them by launching new exchange-traded funds and open-end funds. In fact new launches of alternative strategies have ranged from 368 to 446 each year since 2007, with 441 and 446 funds in 2010 and 2011, respectively, the highest years of activity. This rush to market with new products is not surprising.

    In an industry where low-cost passive products continue to expand their share of fund flows, alternatives represent a welcome turning of the tide to a more active-oriented product line that has favourable economics for manufacturers. What constitutes alternative products can run the gamut from more ‘traditional’ alternatives such as commodities and real estate to hedge fund-like strategies being replicated in retail funds. My focus in this article is on the latter, so let us look at the numbers.