Institutional strategies are a wellspring of inspiration for retail product developers. One such idea that is making its way into the retail market is the supply of alternative investments.
The use by institutions of products that invest in assets other than stocks and bonds has doubled to 16% from 8% over the last 17 years, according to Victor Zhang, president of Wilshire Funds Management. Speaking at Envestnet's webinar, "Institutional Investing Trends for 2013, Zhang said, "The average U.S. equity and bond exposure has been in a secular decline while there has been an increase in allocation to global asset classes and alternatives."
One trend Zhang sees in institutional portfolios is the addition of absolute return strategies. "If one can achieve the same level of returns with less volatility and variability of returns over time, then one can more easily manage the potential outcome and the ability to match liability. Absolute return strategies are one area where alternatives have played a key role. With the evolution of capital markets and the ability to trade a variety of complex securities across markets we see an increased number of institutional asset managers offering absolute return vehicles."
Liquid alternatives, which refers broadly to mutual funds and exchange-traded products that employ various hedging and leverage techniques, have made it possible for this strategy to make its way into retail products. "With the advent of liquid alternatives we're seeing the same pattern of product development for retail investors," Zhang said.
Fixed-income alternatives have also come into focus for both instititutional and retail investors. "Investors are looking for not just long-only fixed income, but long/short fixed income or non-traditional fixed income strategies and vehicles," Zhang said. "This is one area we are seeing in the retail market responding as well with many of the strategic income opportunity-like mutual funds and ETFs."
Alternatives have been "around the institutional side for quite some time. Products that invest in alternatives have traditionally been adopted by family offices and high net worth individuals because the minimums are very high," said Larry Petrone, director of research at Kasina.
One product that has come out of institutions in this space is the alpha-only strategy, also called portable alpha. This strategy aims to capture extra returns (alpha) that can be separated from the changes of the market by hedging the market exposure of the portfolio. "I expect we'll see more of these funds in the future," Petrone said. In this category PIMCO offers the Global Multi-Asset Fund which offers enhanced beta through factor selection, alpha, and downside risk protection. Columbia offers the Absolute Return Enhanced Multi Strategy Fund. GMO offers the Alpha Only Fund.
Another alternative product that has come out of the institutional side is a type of fund that replicates the return of private equity operations by either investing in private equity companies or packaging private equity strategies in a retail product, Petrone said.
ProFunds launched the ProShares Global Listed Private Equity ETF in February 2013. The fund carries an expense ratio of 254 basis points. ALPS also offers a mutual fund that gives investors access to private equity though holdings in publicly traded private equity companies, the ALPS/Red Rocks Capital Listed Private Equity Fund. This fund's expenses range from 125 bps to 225 bps, depending on the share class.
Storied private equity firm KKR launched the Alternative High Yield Fund in October of 2012, putting its private equity expertise into a more accessible form. The fund carries an expense ratio of 120 bps and currently has $115.4 million in AUM.
A non-alternative strategy that has its roots in the institutional side is the portfolio overlay. "This would be global tactical asset allocation and risk parity strategies. These balance out volatility in portfolios by focusing on allocation of risk, rather than allocation of capital," Petrone said. The two largest managers of risk parity strategies are Invesco with its Balanced Risk Allocation Fund and AQR with its Risk Parity Fund.
Ed Egilinsky, head of alternatives at Direxion, said it's not a macro trend that is influencing the shift to alternatives, but rather "it's more that these strategies are now available in a daily valued liquid vehicle."
Alternative investments now make up one to two percent of Direxion's mutual fund assets, Egilinsky said. Products Direxion offers that have roots on the institutional side include: managed futures strategies, commodity strategies that are able to buy and hold, smoothing out the ride for investors, hedge fund strategies and long/short strategies. Direxion plans to launch several alternative products in the next twelve months.
Jeremy De Groot, chief investment officer at Litman Gregory said that many of the funds that utilize alternatives are not up to par. "There have been slim pickings over the past few years of funds that focus on alternatives. We haven't found many in the alternative space that have a long track record of good performance. Most of these carry high expense ratios."
Litman Gregory manages portfolios for high net worth investors, smaller endowments and pensions, but the majority of clients are in mutual funds. De Groot said this has caused the company to look at the institutional area with interest.
Litman Gregory launched its own alternative fund in September 2011, the Litman Gregory Masters Alternative Strategies Fund.
De Groot said the fund brings together four sub advisors: Double Line's Jeffery Gundlach; Loomis Sayles' Matt Eagan and team, FPA's Steve Romick and team; and John Orrico and team Water Island Capital. "We think the manager is the most important element."