ALTERNATIVE INVESTMENTS: Growth seen in alternatives market

DETROIT — Alternatives to traditional stock and bond investments have never been more plentiful — or more complex.
For financial advisers, the fast-changing alternatives marketplace represents both challenges and opportunities. But what the alternatives market doesn’t offer advisers, according to some sources, is the option to sit back and ignore the potential of non-correlated investments.
“The wheel has already been invented by the institutional investors that are already allocating 25% of their portfolios to alternative asset classes, but some advisers still have a minimal allocation to alternatives, at best,” said P.J. DiNuzzo, president and chief investment officer at DiNuzzo Investment Advisors Inc. in Beaver, Pa.
Mr. DiNuzzo, whose firm oversees $250 million in client assets, has an aversion to investing directly in hedge funds, but he still allocates about 25% of his clients’ assets to the alternatives space via mutual funds that employ hedging strategies.
“I tell my clients that hedge funds are bad, and hedging is good,” he said. “We’re not trying to set the world on fire; we’re just trying to hedge the market.”
It is that kind of perspective that is helping to drive the expansion of the alternatives market, where such non-traditional investments as structured products, non-traded real estate investment trusts and mutual funds that apply hedging strategies are being developed with financial advisers in mind.
REITs skyrocket
“We are definitely seeing more forward-thinking advisers coming into the structured-products space,” said Keith Styrcula, president of the Structured Products Association in New York.
Structured products generally involve the use of derivatives to provide investors with a specific balance of capital protection, income generation and capital appreciation. They have fixed maturities, and the condition of each product also is fixed in advance.
According to the SPA’s latest calculations, the structured-products industry is on pace to exceed $100 billion in total annual sales. This compares with $64 billion last year and $40 billion in 2005.
“I think we’ve made some major breakthroughs in the past couple of years,” said Mr. Styrcula, who called structured products “a fit between alternative and traditional investments.”
The story is similar with regard to registered non-traded REITs, an industry that is also experiencing a record-breaking year.
According to the Investment Program Association in Washington, the $7.2 billion invested in non-traded REITs during the first six months of 2007 shattered a 1987 record of $6 billion invested over the comparable period.
Little liquidity
Non-traded REITs, also known as private REITs, are publicly registered but don’t list their shares for trading. As a result, non-traded REITs offer little liquidity to investors.
Total 2007 investments in registered non-traded REITs, which invest mainly in commercial real estate, are expected to surpass easily the one-year record of $10.7 billion set in 1987.
Most people are attributing the growth of these kinds of products — sold primarily through financial intermediaries — to a more sophisticated adviser community that understands the value of an investment that doesn’t move in lockstep with traditional stocks and bonds.
“You can try and pick the right time to be in the stock market or you can do what institutional investors do and diversify for the long term,” said Keith Allaire, a managing director at Robert A. Stanger & Co. Inc., a Shrewsbury, N.J.-based investment banking firm.
While much of the recent growth and evolution of the alternatives industry, particularly with regard to hedge funds, can be attributed
to a growing appetite among
institutional-class investors, financial advisers also are playing a part in driving the development of new products and services.
For example, as the $1.5 trillion hedge fund industry continues to swell in proportion to the appetite for alternatives by managers of pension funds, endowments and foundations, the number of funds of hedge funds, investible hedge fund indexes and hedgelike mutual funds is growing to address the demand of the retail-investor market.
“I’m amazed at the development over just the last six months of registered mutual funds that now offer long/short strategies,” said Ryan Tagal, product manager in charge of hedge fund research at Morningstar Inc. in Chicago.
A current trend along those lines is the development of the so-called 130/30 mutual funds that let portfolio managers leverage up to 130% long and also go 30% short.
“We think the fund industry will start coming out with a lot of those,” said Cindy Zarker, director at Cerulli Associates Inc. in Boston.
“The perception seems to be that the 130/30 strategy is the portfolio management sweet spot, but I haven’t seen any evidence yet to support that,” she said.
Mr. Tagal and others have shrugged off the 130/30 concept as little more than the latest mutual fund marketing gimmick.
“The asset management firms can sense the growing adviser appetite for alternatives, and a lot of advisers will see the 130/30 funds as offering a fixed strategy that is safe,” he added.
Morningstar tracks more than 150 mutual funds that claim
some kind of long/short or market-
neutral investing strategy.
Adding more hedgelike mutual funds to the mix, according to Mr. Tagal, could be an attempt by the fund industry to retain talent.
“The money management firms are trying to both address the hedge fund mania and stave off the migration of portfolio managers to the alternatives side,” he said. “But who knows if these managers can really deliver when it comes to shorting stocks?”
The hedge fund industry, which is estimated to include more than 12,000 hedge funds, is adding about 2,000 new funds a year, according to PerTrac Financial Solutions LLC in Reno, Nev.
“We continue to run into scads of people who are starting new funds,” said Meredith Jones, managing director with PerTrac. “We’re also seeing more diversification in terms of the strategies with a lot of asset-backed-lending funds and country-specific funds.”
However, Ms. Jones added, much of the industry’s development is geared toward multibillion-dollar institutional investors — suggesting a shift away from individual investors, which is in line with the general U.S. regulatory theme to protect retail investors.
“I think advisers are looking for ways to diversify outside of traditional asset management, and the creation of mutual funds in the alternative space is based on that demand,” said Edward Egilinsky, managing director of alternative strategies at Rydex Investments in Rockville, Md.
Ultimately, the asset management industry is coming to terms with the demands of both the pure-play institutional investors and the financial advisers that are realizing the benefits of non-correlated investment strategies.
“I’ve seen global meltdowns, and the dot-com boom and bust, and everything in between,” said Derek Imes, president of Principia Investment Advisors LLC, a Bogart, Ga., firm that oversees $85 million in client assets.
Between 15% and 20% of those assets are allocated to alternative strategies.
“Alternatives are very nice to have in a portfolio when you go to client meetings, and you want to show some non-correlated performance in a portfolio,” Mr. Imes added.