The stock market’s roller-coaster of a ride following S&P’s downgrading of the U.S.’ credit rating on August 5 lent welcome exposure to a segment of the investment world that few life insurance and financial service professionals are well versed in: so-called “alternative investments.” Advisors would do well to take notice of them.
The diverse range of vehicles encompassed by the term include alternative mutual funds and exchange-traded funds that invest in hard assets and commodities, hedge funds, private equity and private real estate, collective trust funds, limited partnerships, managed futures, and other products. They are viewed by a growing number of asset managers as an indispensable component of a client’s portfolio.
The reason for this is because the investments can help increase returns while mitigating risk in volatile markets, in part because they don’t all rise or fall in value in sync with mainstay stocks and mutual funds.
That is music to the ears of advisors who are looking to diversify beyond U.S. equities, which have been battered in recent months by worsening news about the faltering economic recovery. The heightened interest in alternatives–products that were once the province of only the most wealthy, but that are now increasingly available to average investors through (most notably) mutual funds carrying low investment thresholds–is evident in recent statistics.
Alternative mutual fund assets grew 60% in 2010, ending the year at $201 billion, according to a new report from market research firm Cerulli Associates, Boston. While representing just 2.6% of total long-term mutual funds assets (up from 1.9% in 2009), alternatives grew at a much faster rate last year than other mutual funds, which rose only 16%.
As the Cerulli study shows, the severe recession of 2007-2009 led to a significant rise in product demand. In early 2010, 76% of asset managers polled by Cerulli said the financial crisis increased their interest in investment alternatives, a sentiment reflected in the inflow of mutual funds in 2009 ($31 billion) and 2010 ($51.9 billion).
The increasing popularity of alternative mutual funds is also mirrored in the level of product development. In 2010, the study notes, 65 new alternative mutual funds were launched. Prior to last year, the number of new funds never surpassed 50.
Also noteworthy: Much of the money being invested in mutual fund alternatives is going into commodities, which tend to be more attractive than traditional funds in times of uncertainty. Of the 65 funds launched in 2010, three of the top four most successful products are commodity funds.