Alternative Investment Demand Growing - Sort Of!
Thursday, January 20, 2011

Overall usage of alternatives continues to increase among both institutional investors and advisors, but the vehicles they're using to implement these strategies are changing, a new study has revealed.

According to the third annual national survey examining the perception and usage of alternative investments, conducted by research firm Morningstar and Barron's, the financial magazine, more than 70% of institutions expect alternatives to account for more than 10% of their portfolios over the next five years, while 37% (up from 25% last year) expect their portfolio allocation to alternatives to exceed 25%. More than half of advisors surveyed expect to see their clients' allocations to alternatives grow by more than 10% a year over the next five years. The survey results are based on responses from 151 institutions and 669 financial advisors.

"We've seen USD2.7bn flow out of the hedge funds we track through the third quarter of this year, yet USD17.3bn has flowed into alternative mutual funds," said Nadia Papagiannis, alternative investment strategist for Morningstar. "Investors seem to want the best of both worlds when they can get it — the diversification benefits of alternative strategies with the liquidity and transparency of publicly traded vehicles. And the investment industry is responding to this demand. Alternative and commodity mutual funds accounted for 14% of all funds launched in 2010 and 20% of all ETFs."

More than 21% of institutional investors indicated that long-short strategies represent their largest alternative allocation, and it was the strategy most commonly cited for possible future investments. Managed futures was most commonly cited by advisors as the strategy that they intend to consider for investment going forward, and it was the second most commonly cited strategy by institutional investors.

Institutional investors have adopted traditional mutual funds and ETFs to implement more liquid alternative strategies, the survey shows, but continue to use hedge funds to access less liquid strategies like arbitrage, corporate actions, and distressed securities. Advisors, on the other hand, are primarily using liquid investment vehicles to access all alternative strategies.

Investors and advisors also believe that alternatives are growing in importance. More than 70% of the institutions surveyed (up from 63% in 2008 and 64% in 2009) and 66% of advisors (up from 52% in 2008 and 58% in 2009) believe that alternatives will be as important or more important than traditional investments over the next five years.

The survey also revealed that over the past three years, institutional investors have significantly changed their perception of natural resources equities. In 2008, about 80% of institutional investors surveyed considered them alternative investments, but less than 30% would put them in that category today.

However, there was general strong agreement among both advisors and institutional investors that commodity returns are currently being driven more by demand than fundamental valuations.

Despite recent signs of downward pressure on asset management fees, Morningstar's and Barron's survey found that the majority of institutional investors did not receive any fee concessions in the last year, as hedge funds that survived the 2008 downturn retained pricing power.

On the the US Securities and Exchange Commission's proposed Accredited Investor rule change, advisors appeared fairly evenly split in their opinions according to the survey — 56% agreed and 44% disagreed with the rule change. The proposal would exclude primary residence in determining net worth, and potentially limit the access of some clients to private, less-liquid alternative investment vehicles such as hedge funds.