Advisors, as part of their never-ending search for diversification, continue to add alternative investments such as managed futures to their client’s portfolios, though at a slower pace than in year's past.
Plus, some advisors and institutions are shying away from alternative investments citing the high fees and the lack of liquidity associated with such funds, according to Morningstar/Barron’s annual alternative investment survey.
Alternatives continue to gain assets, bucking the trend in U.S. equities, but growth and excitement is cooling, according to the annual survey, which is designed to looking at the perception and usage of alternative investments among institutions and advisors.
For instance, alternative funds saw inflows of $23.2 billion in 2011 ($14.2 billion excluding the nontraditional bond category), while U.S. equity mutual funds bled $84.7 billion. However, inflows were lower than prior years.
Overall, 65% of advisors and 67% of institutions responding to the survey say that alternative investments are as important or more important than traditional investments, which is down slightly from last year’s survey. In general, Morningstar says advisors are less comfortable with alternatives than institutions, as 23% of institutions and 30% of advisors allocated 5% or less to alternative investments in 2011.
Morningstar also says sentiment has cooled to more established equity-based alternatives, but not to non-equity-based strategies such as managed futures and currencies, despite poor performance. For instance, managed futures and currency mutual funds recorded inflows of $3.6 billion and $3.4 billion, respectively, in 2011, despite the fact that managed futures lost 6.9% that year, while currency funds lost money every year since 2008.
For the second year in a row, advisors again cited managed futures as the asset to which they were most likely to increase their exposure, while currency funds didn't make their top five. While still positive, flows into market neutral and long/short equity funds—two more well-established categories—saw far lower inflows in 2011 than in 2010. The least-used alternative investment categories are international small-cap, TIPS, frontier markets, emerging market (stocks), and emerging market (bonds), according to the survey.
Advisors cited other reasons for not using alternatives, including uncertain benefits and lack of transparency.
Brian Ullsperger CIMA, AIF, a managing director with WTAS LLC is one adviser who uses alternative investments in his client’s portfolio. In his case, Ullsperger uses alternative investments such as market-neutral funds, managed futures and long-short funds a way to create consistent returns. “We’re not just looking for alpha,” he says. “We use them to reduce downside volatility.”
At WTAS, which has $1.5 billion in assets under management, the typical client has 10% to 20% of their portfolio invested in alternative investments, mostly of which are ’40 Act mutual funds. Ullsperger says his firm uses ’40 Act funds because those funds provide liquidity unlike alternative investments structured as limited partnerships.
Ullsperger also says he’s not troubled by the high fees often associated with alternative investments. “We look less at fees and more at that value we get for the strategy,” he says. “Fees are an issue only in the absence of value.”