OPINION: Alternatives to Greater Losses, from SI Global

Jag Alexeyev, head of global research and senior managing director at Strategic Insight, explores the future of alternatives through mutual funds.

Investors contributed $22 billion on a net basis to alternative strategy Ucits compliant funds in Europe during the first four months of 2010, a striking acceleration from the $35 billion recorded during all of last year. Most asset managers agree that this trend will continue. The reemergence of volatility and instability reminds investors – and the fund industry – that diversification beyond traditional assets into lower correlated strategies is no longer an alternative, but rather a must.

Market losses in the short-term will curtail fund sales as investors step to the sidelines to figure out next steps. Yet looking further into the future we see, and the data confirms, rising demand for alternative assets with lower volatility and better risk-adjusted returns. The opportunity to deliver these on a wider basis through well-regulated Ucits vehicles in Europe and mutual funds in the U.S., with greater transparency and liquidity, is becoming harder to ignore.

The demand for alternatives goes far beyond the confines and preconceptions around Newcits and hedge fund strategies, and encompasses many other absolute return, commodities, infrastructure, tactical allocation, multi-asset, bear market and inverse approaches.

Appetites for such products are rising, but promises of lower correlations, reduced volatility, and more consistent performance often go unrealized. When they are fulfilled, billions of assets can be raised, so long as managers understand and follow best distribution practice, risk management, and client service. Innovative use of building blocks and packaging (for example, convergence of hedge funds with ETFs and managed account platforms) can also help.

But when promises fail, reputations suffer – hurting not just individual managers but the industry overall. And regulators find more reasons to scale back on fund flexibility and innovation, which could limit everyone’s potential in the end.

Strategic Insight analyzes the future of alternative investments in its recent book, Managing Investment Fund Innovation. For details, visit www.strategicinsightglobal.com/innovation