More institutions and advisors choose mutual funds as vehicle

Mutual funds gained among institutions and advisors as a preferred structure to enter alternative space, according to Morningstar and Barron’s eighth annual alternative survey. More advisors in 2013, 73%, stated that they used mutual funds to invest in alternative strategies including long-short equity or debt strategies. In 2012, only 53% of advisors preferred mutual funds. Similarly, institutions’ preference for mutual funds rose 16% to 48% in 2013 from 32% in 2012. Morningstar and Barron’s had 372 institutions and 301 advisors participate in the survey.

Long-short equity most used alternative strategy

Advisors and institutions reported preference for long-short equity in 2013. Long-short equity funds gained more than 80% in 2013, followed by nontraditional bond and multi-alternative funds. The main reason to invest in these alternative categories was to obtain low correlation with rest of portfolio. More than 25% of advisors are concerned about a future bond market correction and are using nontraditional bond funds. Diversification is a primary driver for advisors and institutions to invest in nontraditional bond funds. Yield and interest rate hedging are secondary considerations when choosing a non-traditional bond fund.

Institutions and advisors: Top drivers to invest in alternatives

mutual funds long-short equity

Source: Morningstar

Launches of long-short equity, multi-alternative and nontraditional bond reach record in 2013

mutual funds long-short equity

Source: Morningstar

Interest and perceived value in alternatives moderating

More than half of advisors and institutions indicated that alternatives are important to portfolios relative to traditional investments. Institutions seem to allocate more to alternatives relative to advisors with 18% allocating more than 40% of a portfolio to alternatives. Only 3% of advisors allocated more than 40% of a portfolio to alternatives. Over time, allocations of 25% or more to alternatives have declined among institutions and advisors. Only 28% of institutions assigned more than 25% of portfolio to alternatives, a decline of 6% relative to 2010. Advisors also showed less interest in a large share of alternatives as only 9% allocated more than 25% of their portfolios in alternatives. This is a 2% drop relative to 2011. Advisors and institutions still believe alternative investments charge high fees, which dampens their interest in the asset class.

Institutions: Allocation to alternative investments over time

mutual funds allocation

Source: Morningstar

Advisors: Allocation to alternative investments over time

mutual funds alternative allocation

Source: Morningstar

Advisors and institutions emphasize manager experience in selection

Both advisors and institutions mention manager experience in managing alternative investments as the main criteria to choose a fund. Amount a manager invests in their alternative products and alternative assets under management for a given firm are secondary considerations. Institutions placed more importance on investment process while advisors focus more on fees.

Regarding performance evaluation, advisors and institutions use standard benchmarks such as the S&P 500 (INDEXSP:.INX) for their alternative investments. The second most used benchmarks are peer groups and risk adjusted analysis.