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Annual Survey Finds Continued Interest in Alternative Investments

Shift from Hedge Funds to Alternative Mutual Funds

Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, and Barron’s, the financial magazine published by Dow Jones and Co., today released highlights of their fifth annual national survey examining the perception and usage of alternative investments among institutions and financial advisors.

“Alternative mutual funds and ETFs have grown in breadth and quality in recent years,” Nadia Papagiannis, director of alternative funds research for Morningstar, said. "Institutional investors are starting to see alternative mutual funds as substitutes for hedge funds, and more financial advisors are incorporating these liquid, transparent investments into their client portfolios."

Morningstar and Barron’s conducted the survey in March 2013 and received responses from 235 institutions and 471 financial advisors. Among the major trends in alternative investment usage and perception:

Investor interest turning to alternative mutual funds; away from hedge funds

• Mutual funds are becoming the dominant vehicle used by both advisors and institutions to access the majority of alternative strategies. Alternative mutual funds saw inflows of $19.7 billion in 2012, while Morningstar estimates that among funds in its database, $7.6 billion flowed out of single-strategy hedge funds.

• While 61 percent of institutions said they accessed long-short strategies via hedge funds in 2010, only 26 percent indicated that they used hedge funds for that strategy this year. In contrast, more than 45 percent of institutions said they access long-short strategies via mutual funds versus 38 in 2010.

Institutions and advisors continue to see value in alternatives

• Among institutions, the number of “heavy users” of alternatives seems to be growing. More than 20 percent of institutions, compared with 17 percent last year, said they expect alternative investments to make up more than 40 percent of holdings over the next five years.

• Only 4 percent of advisors said their typical client had no money in alternative investments, down from 17 percent in the 2008 survey.

Institutions maintain interest in equity long-short strategies; advisors search for yield

• In 2012, the long-short equity and nontraditional bond categories saw the largest alternative mutual fund flows of $6.1 billion and $5.9 billion, respectively.

• For the second year in a row, institutions again flagged long-short equity strategies as their top choice for increased allocation—the strategy ranked second for advisors.

• Advisors also expressed particular interest in yield-producing alternatives. They cited private real estate as their top strategy for planned future investment. In addition, advisors indicated that master limited partnerships (MLPs) drove significant portfolio growth over the last five years.

• Advisors shied away from managed futures in 2012 after citing them as their top pick in the two previous surveys. Performance may have been a factor as managed futures ETFs and mutual funds lost 15.6% and 7.4%, respectively, in 2012, similar to their losses in 2011. Institutions and advisors also expressed distaste for the undisclosed performance fees managed futures funds frequently charge.

Diversification still driving alternative investments, but high fees now the primary concern

• High fees have overtaken liquidity and transparency as the primary reasons why advisors and institutions may choose to forego alternative investments.

Highlights and commentary from the survey appeared in the June 24 issue of Barron’s in the “Fund of Information” column.