Apparently undeterred by the second-most significant crash in the history of the U.S. stock market, the majority of institutional investors and financial advisors plan to increase their use of alternative investments despite their poor performance during last year's financial meltdown. A recent survey from independent research firm Morningstar and Barron's financial magazine indicates that instead of the market's meltdown leading to more conservative investor behavior, money managers and financial advisors are doubling down on some of the same investments that wiped out trillions of dollars and ruined many.
"Both institutions and advisors continue to view alternative investments optimistically, despite their questionable performance, correlation, and liquidity during last year's global downturn," said Steve Deutsch, director of the pension, endowment, and foundation database at Morningstar. "Again this year, the majority of participants indicate that they plan to increase allocations to alternatives, but with greater scrutiny and due diligence given to those investments."
This mean that pension funds and the retirement accounts of individual investors will see increased investments in financial vehicles that have historically been less liquid, less transparent, more difficult to understand and more risky. More than 60 percent of institutions and financial advisors expect alternatives to be as important as or more important than traditional investments over the next five years. The majority of both groups said 10 percent of their portfolios would be made up of alternatives over the next five years and a quarter of institutions expect alternatives to account for more than 25 percent of their portfolios.
Deutsch said money managers and advisors are willing to increase their use of alternative investments because the definition of what alternatives are has changed. Further, he said, "The level of confidence in going long in the domestic market is not as strong as looking for alternative strategies that can take advantage of the very uncertain and somewhat disturbing market trends of the present time."
Stepping Up Their Due Diligence
Those "alternative strategies" include using exchange traded funds that have shorting capabilities or absolute return mutual funds that can help minimize losses. The survey revealed that money managers now define alternative investments by the investment strategy used, not the actual vehicle. Real estate investment trusts and commodities, which were traditionally considered alternative investments along with private equity, hedge funds, managed futures, private debt and infrastructure, are no longer considered alternatives by many.
Deutsch said this shift has taken place because institutional managers and advisors are trying to get the best of both worlds. They want investments that allow diversification of asset classes, absolute returns and the flexibility of using different investment techniques like shorting or arbitrage, but they also want investments with transparency, a fair fee structure and the liquidity to allow fast redemptions if needed.
Deutsch also said that the survey showed that institutional managers and advisors have stepped up their due diligence on the vehicles they select for their portfolios in order to understand exactly what these vehicles are holding. "They are going to be using alternatives on an increased basis, but with a careful eye toward the details."
He believes that if money managers do their homework, the increased scrutiny of products will allow them to choose alternative investments that can provide positive results for investors. After the results of the last year, the investment community can only hope that is the case.
Learn the most important step in structuring an investment portfolio.View Course »