Poor performance hasn't scared advisers away from alternatives mutual funds, even as large institutional investors are scaling back.
Through the first six months of the year, nearly $6 billion was invested into such mutual funds. That follows on the heels of $14.9 billion of inflows in 2011 and $15.8 billion in 2010, according to Morningstar Inc.
Since the start of 2011, more than $130 billion has been withdrawn from U.S. stock funds.
However, the performance of the two asset classes has been the exact opposite.
During the 12-month period ended July 13, the S&P 500 returned 3.86%, the Dow Jones Credit Suisse Hedge Fund Index returned 0.82%, and many of the alternatives categories Morningstar tracks showed similarly poor results. The managed-futures category, for example, lost nearly 8%, long/short equity was down 2.6%, and market-neutral was down 1.15%.
While the money keeps flowing into alternatives mutual funds, institutional investors are beginning to scale back their exposure. According to a recent survey by Morningstar and Barron's, 26% of institutions plan to allocate 25% or more to alternatives, down from 37% a year earlier.
“It seems institutions got a bit ahead of themselves with alternatives in 2010,” said Mallory Horejs, an alternatives analyst at Morningstar. “One possible explanation on why they were so bullish was lingering concerns following the flash crash,” she said.
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ACCESS AND FEAR
The main reasons for the momentum of flows into alternatives mutual funds are access and fear.
Prior to the boom in such funds — there were 150 in 2008 and more than 300 today — hedge funds were the only vehicle that offered alternative investment strategies. But hedge funds came with their own unique characteristics, such as high fees and limited liquidity, that kept advisers away.
There's also a hefty amount of fear in the air. Investors are worried over the outcome of the European sovereign-debt crisis, the domestic fiscal cliff, the upcoming election and any surprises that may cause stocks to crater like it's the fall of 2008 all over again.
Thomas Balcom, founder of 1650 Wealth Management, has been adding alternatives to his client portfolios for downside protection and for the lower volatility the strategies tend to offer.
“We want to invest, but we hate seeing stocks go up and down 5% every quarter,” Mr. Balcom said. “We're willing to give up some of the upside for a smoother ride.”
BOND PROTECTION
Gary Vawter, principal at Vawter Financial Ltd., is using alternatives to protect against a down market, but he's also using the funds to protect against falling bond prices.
“The greatest risk is on the fixed-income side,” Mr. Vawter said. “There's been a 30-year bull market in bonds; the only direction they can go is lower.”
Whether advisers are worried about stocks, bonds or both, it's clear that the traditional asset classes aren't making it any easier for them to sleep at night. That's leading advisers to the alternatives space.
“It's about finding different kinds of risk,” said David Kabiller, principal at AQR Capital Management.
In fact, more than 80% of advisers in a recent survey by Morningstar and Barron's listed diversification as the No. 1 reason for allocating to alternatives.
While the vast majority of advisers agree on why alternatives make sense in a client's portfolio, there's wide latitude in how much exposure they want.
“The challenge folks are having is the application,” said John Moninger, executive vice president of advisory and brokerage consulting at LPL Financial LLC.
Mr. Moninger said it's not uncommon to see LPL's advisers with 10% to 15% in alternatives, but in certain situations he would recommend an even higher allocation.
Scott Curtis, president of Raymond James Financial Services Inc., said the typical adviser at his firm is allocating between 3% and 5%.
The percent of advisers allocating zero to 10% to alternatives rose from 40% to about 45%, according to the Morningstar survey.
GETTING COMFORTABLE
Once advisers get comfortable with alternatives, Mr. Kabiller said, the typical allocation settles in at about 25%, which is around what Mr. Balcom uses for his clients.
Given the variance in how much advisers are allocating to alternative strategies, it comes as no surprise that asset management firms are rushing to make it easier to handle allocation among the different flavors.
Since 2008, more than 50 multi-alternative funds, such as the Neuberger Berman Absolute Return Multi-Manager Fund (NABAX), have been launched — the most of any alternatives category.
It's not uncommon to see advisers start off with small allocations to get a feel for the asset class, according to Mr. Kabiller.
“You've got to walk before you can run,” he said.
Multialternative funds combine a number of strategies into a sort of one-stop alternatives shop for advisers.
Managed-futures funds, however, which invest in trends in futures markets such as commodities, are the alternatives strategy advisers have their eyes on.
One out of 10 advisers in the Morningstar survey listed managed futures as the alternatives strategy they believed would best help expand their business.
jkephart@investmentnews.com Twitter: @jasonkephart
