The Hedge Edge Moves to Mutual Funds

By Hal M. Bundrick

NEW YORK ( MainStreet)--The landscape for tactical investments is undergoing a sea change. Hedge funds are being trimmed, while alternative strategy mutual funds are gaining favor, according to a national surveyregarding the use of alternative investments by institutions and financial advisors conducted by Morningstar and Barron's.

Money poured into alternative mutual funds last year with inflows of $19.7 billion, while Morningstar estimates that among funds in its database, $7.6 billion flowed out of single-strategy hedge funds.

"Alternative mutual funds and ETFs have grown in breadth and quality in recent years," Nadia Papagiannis, director of alternative funds research for Morningstar, said. "Institutional investors are starting to see alternative mutual funds as substitutes for hedge funds, and more financial advisors are incorporating these liquid, transparent investments into their client portfolios."

Institutional money managers favor long-short tactics and are replacing hedge funds with mutual funds to tap the strategy. 45% of institutions said they access long-short strategies via mutual funds, up from 38% in 2010. Long-short hedge funds accounted for just over one-quarter (26%) of institutional holdings in 2012, a long fall from the from 61% allocation held in 2010.

Meanwhile individual financial advisors are looking to enhance yield, preferring private real estate funds and master limited partnerships (MLPs).

Managed futures may be an investment tool of the past. While financial advisors ranked the strategy as their top pick for each of the past two years, poor performance has pared its popularity. Managed futures ETFs and mutual funds lost 15.6% and 7.4%, respectively, in 2012, with equivalent losses in 2011.

High fees associated with alt mutual funds continue to be a concern to money managers according to the survey, however more than 20% of institutional portfolio advisors said they expect alternative investments to comprise at least 40% of allocations over the next five years.

--Written by Hal M. Bundrick

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