Advisors, asset managers and institutions are increasingly turning to alternative investments to help clients boost returns while supporting the growth of assets under management, according to several separate studies released in late May and early June show.
“Institutional investors and financial advisors have significantly expanded their alternative holdings since the 2008 crash, and continue to view alternative investments as an important part of their portfolios,” said Scott Burns, director of ETF, closed-end fund, and alternative research for Chicago-based Morningstar, in a statement. “Growth has begun to slow, though, as investors have ramped up their allocations, and excitement may be cooling with the lackluster performance of alternatives relative to the overall market over the last few years.”
For sure, alternatives continue to gain assets, bucking the trend in U.S. equities: Alternative mutual funds had inflows of $23.2 billion in 2011($14.2 billion excluding the non-traditional bond category), while U.S. equity mutual funds bled $84.7 billion. Still, inflows were lower than prior years; alternative ETF inflows for 2011 were only $11.6 billion, the lowest level since 2006, while inflows for alternative mutual funds were $1.8 billion less than in 2010.
About 65% of advisors and 67% of institutions indicated that alternative investments are as important or more important than traditional investments, down slightly from the 2010 survey. Institutions indicated rising interest and investment in alternative investments in 2008, 2009 and 2010. But in the 2011 survey, there was some retreat: Among the institutions surveyed, 26% indicated they plan to allocate more than a quarter of their portfolios to alternative investments, down from 37% in the last survey.
Boston-based Cerulli says its annual examination of the retail alternatives and ETF marketplaces found that asset managers expect alternative mutual funds to comprise nearly 10% of all mutual funds within five years. Plus, this percentage should jump to more than 15% in 10 years.
In a separate study conducted by Practical Perspectives, a Boston-based consulting and research firm, financial advisors said they expect continued growth in their use of alternatives and nontraditional investments. Most advisors currently allocate up to 15% of a typical client portfolio to these products, which is likely to increase as advisors grow more familiar with their benefits and uses, the report concludes.
“Interestingly, the need to differentiate in a competitive marketplace was the leading driver in 2011, and is considered much less of a driver in today’s market,” said Alec Papazian, lead author of the Cerulli report, in a press release. “We attribute this to the fact that so many managers now offer these strategies. 2011 was a record year for alternative mutual fund product development with 95 new funds being launched.”
Cerulli’s latest research shows that the leading driver behind asset managers’ interest in alternatives—nearly 90% of advisors cite it versus fewer than 75% last year—is tied to investors’ need to optimize the risk-adjusted performance of their portfolios. Another significant driver, for 72% of advisors surveyed in 2012 versus 60% in 2011, is managers’ expectations regarding future capital-markets returns.
The Practical Perspectives study finds that financial advisors can be divided into three core segments based on the likelihood of using alternatives and nontraditional investments for clients: heavily engaged, 30%; moderately engaged, 34%; and minimally engaged, 36%.
The study also concludes that most advisors, 60%, are allocating 10% or less to these products, though advisor use of alternatives and nontraditional strategies has increased notably in the past two years.
“Alternatives and nontraditional investments are increasingly important to advisors in serving retail clients,” said Howard Schneider, president of Practical Perspectives and a co-author of the report, in a press release. “This growth has been spurred by the challenging capital markets and the expanded availability of these strategies in mutual fund and ETF formats.”
The firm’s research emphasizes that the desire to enhance diversification and lower portfolio volatility and risk are the main factors driving increased use of alternatives and nontraditional investments. Plus, most advisors use mutual funds or ETFs as the main vehicle for investing in alternative products.
The most important factors in selecting alternatives and nontraditional investments are the expertise of the investment manager and the low correlation relative to more traditional investments.
Need for Education
“The audience for alternatives and nontraditional investments is definitely expanding,” noted Richard Gauger of Practical Perspectives, a co-author, in a statement. “Yet many advisors still lack familiarity with these strategies.”
According to Gauger, advisor satisfaction is lagging “relative to the importance they place on factors such as wholesaler support, product research and due diligence.” There is a direct correlation between satisfaction with support and advisor use of these strategies, he adds, so “product providers and platforms should be focusing resources more effectively on key audiences.”
For its part, Cerulli says its research shows that distribution access and advisor knowledge are the largest challenges facing alternative managers. Still, many broker-dealers, in particular the wirehouses, appear very supportive of increasing the use of alternatives among their advisors. On average, wirehouses see allocations at only 4% among their advisor forces but would like this to increase to greater than 15%.