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Annual Survey Finds Continued Rise of Mutual Funds as Vehicle of Choice for Alternative Strategies

Long-Short Equity Garners Most Investor Interest for Fourth Year in a Row 

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 annual national survey examining the perception and usage of alternative investments among institutions and financial advisors. This survey is now in its eighth year. 

“Mutual funds continue to grow as the vehicle of choice for accessing alternative strategies. 2013 marked the strongest asset flows into alternative funds and the largest number of fund launches on record,” Josh Charlson, director of manager research, alternative strategies, said. “For the fourth year in a row, long-short strategies garnered the most interest, but growing apprehension toward the bond market has also contributed to blistering growth in nontraditional bond funds.”

Morningstar and Barron’s conducted the survey in March 2014 and received responses from 372 institutions and 301 financial advisors. Among the major trends in alternative investment usage and perception:

Long-short equity strategies continued to lead the way; interest also turning to multialternative and nontraditional bonds:

  • Organic growth rates for mutual funds rose to eye-popping levels. Long-short equity funds rose by more than 80 percent in 2013, followed by nontraditional bond and multialternative funds. Advisors and institutions both cited long-short equity and multialternative as top strategies for investment over the next five years.
  • Assets surged in the nontraditional bond category in 2013 as more than a quarter of advisors cited a poor bond market outlook as a principal reason to invest in alternatives. Advisors and institutions indicated, by a significant margin, that they valued fixed income alternatives more for their low correlation than their yield and interest-rate hedging. 

Mutual funds accelerate as vehicle of choice for alternative strategies; investments concentrated in few funds:

  • Mutual funds continued to make gains across the board as a preferred means for accessing alternative strategies. Mutual funds jumped to 73 percent from 57 percent in last year’s survey as the stated vehicle of choice for advisors to access long-short equity or debt strategies and to 48 percent from 32 percent for institutions accessing managed futures strategies.
  • Assets in alternative mutual funds are extremely concentrated. As of May 2014, almost half of all alternative mutual fund assets in Morningstar’s database were concentrated in the 10 largest funds. 
  • Still interest and perceived value in alternatives, but enthusiasm may be moderating; fees remain a concern
  • Alternative investments remain important for both advisors and institutions with more than half indicating that they were as important or more important than traditional investments, but enthusiasm may be cooling. Fewer institutions and significantly fewer advisors cited alternatives as “much more important” than traditional investments in this year’s survey than they did in 2010. 
  • After record inflows into alternatives in recent years, growth in alternatives may start to ease, especially for advisors. In the 2010 survey, more than half of advisors said they expected to increase their allocations to alternatives by more than 10 percent per year; only 39 percent said the same this year. 
  • Advisors and institutions say the biggest sticking point for buying alternative investments is still their relatively high fees.

Manager experience trumps “skin in the game” when it comes to investment selection; standard benchmarks still the standard:

  • When selecting alternative products, both advisors and institutions agree that manager experience trumps other evaluation metrics, such as a manager’s investment in the strategy and the amount of a firm’s assets in alternatives. Institutions also placed emphasis on investment process while advisors were more concerned with fees. 
  • Suggesting that there is opportunity for new players to enter the alternatives space, only about 6 percent of both advisors and institutions said they consider a firm-wide core competency in alternatives an important factor in selecting a strategy. 
  • Surprisingly, standard benchmarks, such as the SandP 500 Index, are the most common forms of alternatives benchmarking. Peer groups and risk-adjusted analysis follow close behind as benchmark options.

Highlights and commentary from the survey appeared in the July 7 issue of Barron’s. The complete survey results, including charts, can be viewed online.

Morningstar has approximately 5,500 active hedge funds and funds of hedge funds in its database as well as 780 alternative mutual funds and ETFs. Morningstar analysts cover about 70 percent of mutual funds in the alternative category by assets. The company also offers a family of alternative indexes. Through its recent acquisition of ByAllAccounts, Morningstar aggregates financial account data for alternative investments and delivers it directly to portfolio accounting platforms. Click here to request more information about ByAllAccounts’ alternative investment aggregation. Hedge fund investors, managers, consultants, and advisors can research alternative strategies through Morningstar DirectSM, the company’s global research platform for institutions.