Total assets in registered alternative mutual funds and exchange-traded funds are projected to reach $330 billion by year-end 2012—nearly double the $169 billion of assets in 2007. If the industry can raise advisors’ and clients’ comfort level with liquid alternatives, that figure could virtually double again, to $650 billion in 2017, according to a new study by Financial Research Corporation (FRC).
For such growth to be realized, these funds must clarify the advantages they might be able to provide. “Investors remain extremely risk averse and continue to place a high value on portfolio diversification and volatility management,” Robert Martorana, lead author of the study, said in a statement . “Registered alternative funds have demonstrated a track record of providing effective diversification, but product providers clearly need to commit more time and resources to getting that message across to consumers and their advisors.”
As part of its survey, FRC found that many consumers view “reducing portfolio volatility” as an important financial objective. However, even though registered alternative funds are designed to provide more of the portfolio stability that investors say they want, most investors are reluctant to move money from more familiar investments.
“Despite their focus on risk and volatility, consumers show a great deal of skepticism towards alternative investments,” stated Alan Hess, FRC research associate and study co-author. “In our survey, more than 40% said that liquid alts ‘seem risky.’ That indicates that consumers aren’t familiar with how alternatives work, and the irony is that this risk aversion means that investors are missing out on products that are designed to limit volatility.”
FRC also found that about one-third of financial advisors are comfortable including them regularly in client portfolios, but most want more education before increasing their use of these products. “When advisors understand how alternatives work, they use the products more often and in a way that brings the most benefit to their clients,” stated Martorana, a consultant at FRC who is currently a portfolio manager specializing in alternative investments at Right Blend Investing. “But only about one-third of the advisors we surveyed said they use liquid alts regularly. When we asked the group what it would take for them to increase their use of ’40 Act funds, ‘education’ was the clear preference.” (Investment companies registered under the Investment Company Act of 1940 may be known as ’40 Act funds.)
“These days, the spirit of the times is risk aversion. Liquid alternatives can provide the diversification and non-correlation with traditional assets to fill that role,” Martorana stated. “Education of both advisors and investors on the benefits and uses of registered alternative funds is the foundation of future portfolio construction.”