For the second consecutive year, Morningstar and Research have surveyed advisors nationwide on their perception of and experience with alternative investments.
[Note: Charts appear at end of article.]
Our September survey found that:o the growth rate in alternative AUM in the last five years has slightly moderated o the growth rate in alternative AUM anticipated for the next five years is also lowero the alternative products that have driven increases in the recent past and which are expected to drive growth in the near future have changed in the past yearo 130/30 products, which Morningstar identifies as “leveraged net long” investment strategies, have not yet had much impact on non-institutional investors.
It bears noting that the timing of our survey coincided with the meltdown in subprime mortgages. The resulting headlines seem to have had a tangible influence on the opinions and outlook of financial advisors as regards hedge funds, private equity activity and other investment alternatives.
Of the statistically significant 717 respondents to our Internet-based survey (sent to readers of Research and advisors who are customers of Morningstar), the typical respondent was an advisor affiliated with an independent broker-dealer or an RIA, with 100 to 200 clients, under $500,000 in gross production/income and under $100 million in AUM. This profile is important to keep in mind in reviewing the results that follow.
We expanded the definition of alternative investments in the 2007 survey to now include art, infrastructure, natural resources, precious metals and weather derivatives.
Advisors agreed with the investments we added to the list. The highest level of agreement by advisors on which products to define as “alternative” was for hedge funds — 93 percent agreed with including them. The sibling poster child of non-traditional investing is private equity, as 92 percent of advisors agree that it is indeed “alternative.”
Advisors also gave their input on what they consider alternative and there were numerous mentions of collectibles, long/short funds, managed futures, oil and gas investment vehicles, and REITs — both public and private.
In 2007, 83 percent of advisors have at least some of their clients invested in alternatives. A plurality of advisors, 38 percent, have 1 percent to 10 percent of their clientele using alternatives; 17 percent of advisors report 11 percent to 25 percent of their clients are invested in alternatives. An impressive 12 percent of advisors indicate that over three-quarters to all of their clients are using alternatives. (See Chart 1.)
A high percentage of portfolios, 77 percent in 2007, have less than 10 percent of their assets allocated to alternatives. But 12 percent of advisors have allocated as much as 11 percent to 15 percent on average of their clients’ portfolios to these types of holdings. (See Chart 2.)
Looking back over the last five years, however, 41 percent now estimate that they have experienced double-digit growth in alternative AUM every year for the past five years. In 2006, 57 percent of advisors reported such a strong average yearly growth rate. Significantly fewer advisors have been experiencing strong growth from alternatives in 2007. (See Chart 3.)
A moderation in growth is also apparent when we asked advisors to look ahead. In 2006, 65 percent of advisors expected double-digit growth in alternative AUM every year for the next five years. This year, only 44 percent of advisors are that optimistic their business will grow accordingly. The majority of advisors, 56 percent, only expect growth rates varying between 1 percent and 10 percent every year for the next five years. A full 21 percent more advisors than in 2006 expect this slower rate of increase; last year only 35 percent were expecting such modest annual growth rates. (See Chart 4.)
We examined the results for expected growth rates by the different “demographic” groups in the survey. Regardless of practice type or number of clients, the lowered expectations were remarkably similar.
In a similar vein, perhaps more realistically than last year, a full 67 percent expect alternative investments to become less important relative to the traditional investment choices of stocks, bonds, mutual funds, etc. over the next five years. That’s 15 percent more advisors with a diminished outlook over 2006. And of that 67 percent, 33 percent think alternatives will be “much less important,” not just “somewhat less important.” (See Charts 5 and 6.)
Last year, lack of understanding was the No. 1 reason clients and advisors hesitated to invest in alternatives, followed by lack of liquidity, and then fees. In 2007, lack of liquidity is the No. 1 deterrent, followed by lack of understanding, and then lack of transparency.