UBS Group AG is preparing to roll out new tools to increase hedge fund use by its financial advisers in the U.S., encouraging increased sales of the alternative investments to a sometimes-reluctant clientele.
UBS is developing a suite of tools that will offer guidance on why advisers should — or in some cases should not — include hedge funds in their asset allocations for clients, according to Andrew Lee, a managing director and head of alternative investments at UBS.
The world's largest wealth manager and its peers have long been recommending the funds to improve the overall risk exposures of portfolios built by their advisers. The firms and their advisers can also win a percentage of the often-hefty performance fees charged by those funds' managers.
But the actual allocations of advisers have remained far lower than is recommended, which analysts attribute to a variety of factors, including insufficient education about how to use alternatives, greater adviser familiarity with competing investment products and the reality that the funds get zinged for high fees or are
unfavorably compared — fairly or not — to a soaring market in U.S. stocks.
“While we see certain segments of investors that are quite willing to accept illiquidity and complexity, there are others who don't see the tradeoffs and aren't always looking at portfolios on a risk-adjusted basis,” said Mr. Lee.
The first tool that will be deployed, called the Hedge Fund Navigator, will tell advisers whether the firm believes the risks of hedge fund investing generally are low, medium and falling, medium and rising or high.
Those predictions are based on an algorithm that evaluates as many as three dozen variables intended to establish whether market, economic, liquidity and volatility risk factors support making allocations to hedge funds.
The underlying variables include factors such as the yield premium earned on corporate bonds relative to government debt, also known as credit spreads; consumer borrowing rates; the level of the VIX, a options-based measure of stock-market volatility; and crowded trades, when managers flock to a similar strategies and erode their potential to generate returns.
At the moment, the algorithm indicates the risks facing hedge funds are low.
The tool is already in the process of being rolled out across the firms' non-U.S. advisers. UBS has 7,114 advisers in its Wealth Management Americas division.
Most UBS clients access hedge funds through feeder funds. The brokerage pools those assets together, allowing investors to commit a lower amount of assets that would otherwise be required to access a hedge fund.
Reinforcing their commitment in the area, the firm installed a global chief investment officer for wealth management and private banking this summer, Mark H. Haefele, an economic historian who got his start in the financial services industry as a long-short equity manager.
So far, financial advisers have been reluctant to make the allocations to hedge funds suggested by their firms. Their exposure to alternatives generally has been in the single-digit percentages, while UBS recommends allocations of just under 20%.
Meanwhile, mutual funds, which track fewer investment strategies but are not subject to the liquidity restrictions and performance fees of limited partnerships,
have been more readily adopted than hedge funds
at wirehouses.
Last year just 19% of advisers surveyed by research firm Cerulli Associates reported plans to increase their allocations to hedge funds, compared with 36% increasing their allocation to alternative mutual funds. The average allocation to hedge funds reported by advisers in 2013 was 0.9%, Cerulli said.
“They need education on all levels — clients, financial adviser and firms themselves — not only what hedge funds are, but how to implement them,” said Joseph M. Labella, a former UBS adviser who specializes in alternatives and who now acts as director of investments for Consolidated Portfolio Review Corp., which is based in Locust Valley, N.Y. “There's a lot of trepidation.”
Nonetheless, the $2.82 trillion hedge fund industry has become a cornerstone of institutional asset allocations and continues to win assets. Over the first three quarters of the year, assets in the funds increased by 7%, according to Hedge Fund Research Inc.
Still, Mr. Labella said advisers tend to be more familiar and more comfortable with the lower cost structure of mutual funds. He said hedge funds are often compared wrongly with benchmarks like the S&P 500 despite the managers' diverse aims and investment strategies.
The performance of funds this year hasn't helped. The HFRI Fund Weighted Composite Index, a composite of hedge fund performance, returned 3.7% this year, as of Dec. 5. The S&P 500, on the other hand, is up more than 10% this year.
“From a performance perspective, when you look at it on an overall basis hedge funds have certainly faced some challenges,” said Mr. Lee. “It certainly has not been the easiest year but, as with all alternative strategies, there's performance dispersion. We have funds on our platform that have done quite well and others that have not done so well.”
UBS analysts have been arguing that “alpha-oriented” hedge fund strategies were taxed this year by low volatility and high liquidity. They said they expect that trend to be reversed next year, benefitting strategies like long-short equity and discretionary macro funds.
While the Navigator won't recommend specific products, UBS said future tools will attempt to identify the quantitative factors underpinning specific hedge fund strategies.
