Alternative mutual funds didn't quite see smooth sailing in 2012, taking in only $19 billion in new cash in 2012.
That compares to $24.4 billion in 2011 and $45.8 billion in 2010, according to Morningstar. Total assets under management reached $150.6 billion in 2012.
But Direxion Funds, a Newton, MA-based provider of alternative mutual funds and exchange-traded funds, maintains that alternatives are a viable alternative to fixed income investments.
So how to turn investors to alternatives? "Have the difficult conversations," says national sales manager John Cadigan, national sale manager at the firm. He spoke with Money Management Executive about the challenges of introducing alternative mutual funds to advisors.
What are some challenges the fund market is currently dealing with that Direxion wants to address?
There are a couple of trends we're trying to take advantage of or to solve for. As a general industry, there's just so much market uncertainty that you continue to see money just pour into fixed income.
But high-quality paper just isn't generating enough income. If you look at the independent broker-dealers, fixed income accounts for over 50% of client assets. There's a lot more credit risk being taken on, which is problematic. We're trying to encourage financial advisers to get off easy conversations (i.e. fixed income) with clients because it's just generated a positive return for so long.
It's different to say long/short equity or managed futures, most retail investors haven't heard of them. I think our mission is the mission of our constituent firms: Get them to incorporate more alternatives. They're here to stay, and their quality, fees and transparency are getting better. People are cynical and skeptical at this point in time, they can't take another asset blow-up.
What's been Direxion's solution to getting people out of that fixed income mindset?
We want to educate advisers on the merits of alternatives over fixed income. If you're going to have an impact on your portfolio, most firms recommend 20%.
But the average usage is only 3%. Our concern is what's going to happen to revenue stream if fixed income funds go south and interest rates go up. Some of the larger firms are looking to simplify and consolidate. They're concerned about the complexity of wealth management, so they're really trying to go away from the single financial advisor model and go into registered investment advisers with teams of analysts, where you have more of specialization within those teams and more discretion over assets. These teams usually are closer to 15% or 20% in alternatives. Meanwhile, alternatives allocations fall off precipitously among independent broker-dealers, which tend to be strictly single financial advisors.
Somehow it's the most aggressive portfolios that give the heaviest weighting to alternatives, when in fact, you need more alternatives when you're trying to keep downside risk down and keep people invested within portfolios. It's the person who's most conservative and needs the most money who needs the most protection. The industry at some point is going to recognize this.
Any particular types of alternatives that you favor?
We like commodities. We believe our long-flat commodity (fund) is a more strategic position than long-only, which is tactical. Commodities are being used as a diversifier, but we think we've got a better mousetrap.
Most people who invest in commodities are investing in long-only. They treat all commodities the same, which means to say they treat corn the same way as they treat energy. But they're not the same, and they have to be going up to profit. We want to change the way people get exposure to it. We have a system that will put you into the ones that are running and avoid the ones that are in decline.
We've taken a tradable asset class and made it more buy-and-hold. Our mechanism is, participate in the upside, protect against the downside.
We also like managed futures, because it protects against fixed income risk. I've heard people use the term "air bag" for their portfolios.
Most of the larger strategies did great in '08, but a lot of them have struggled; ours have done alright. We think it's an opportunity to go into the strategy after a period of duress and really make some money.
Managed futures as an asset class has back-to-back years of negative return. People believe in the trend of reverse in every other asset class: you make money when you buy low and sell high. Managed futures are also introducing a true risk management tool within an investment portfolio. They ranked fourth in overall flows last year. We think it's performance-driven.
It's a great strategy, and we also provide it at one of the lowest costs in the industry. And when an asset class is challenged, fees do matter.