Morningstar Study Says Hedge Funds Are Now Mainstream

by Carla Johnson, Investors Offshore, London

27 October 2006

A new survey by investment research firm Morningstar reports that alternative investments such as hedge funds and real estate are becoming mainstream investments, while a new definition of "alternative investments" in North America could encompass capital-protected and structured products, commodity funds, and managed futures.

Highlights of study were released this week. The full survey, which will appear in the November issue of Research, examines alternative investment usage by advisors. The survey was developed to help gauge the actual impact of alternative investments on advisors and their clients’ portfolios. It was also created in response to industry debate over hedge fund regulation, including the now voluntary hedge fund advisor registration and the argument for raising the monetary amount that defines an accredited investor that was made by U.S. Securities and Exchange Commission Chairman Christopher Cox.

The study found that investors’ number one reason for hesitation in choosing alternative investments is a lack of understanding, followed closely by a lack of liquidity, and fees. Study results also indicate that the majority of financial advisors favor hedge fund advisor registration, be it voluntary or federally required.

"The financial advisory industry knew anecdotally that the state of alternative investments had shifted, but we were surprised to find that the majority of advisors expect double-digit growth in alternative assets under management every year for the next five years," said Steve Deutsch, CFA, director of separate accounts and managed investments for Morningstar. "The rise in usage indicates that financial advisors see alternative investments as smart financial choices for some of their clients, and that further transparency will help advisors and their clients gain confidence to consider adding these investment vehicles to their portfolios. We’re interested in tracking how alternative investments fare and which issues are most relevant to advisors and their clients, such as hedge fund advisor registration, which we learned has strong support."

Morningstar and Research conducted the Internet-based survey and analyzed the results, which captured responses in August 2006 from 600 financial advisors nationwide with collective assets under management of more than $100 billion. Advisors were asked for comments on a range of questions affecting the alternative investments category.

Other highlight findings of the study include that:

• Two-thirds (or 67 percent) of advisors surveyed report that more than 10 percent of their clientele are currently using alternative investments.
• Most client portfolios typically have less than 10 percent of their assets allocated to alternative investments.
• Sixty-five percent of financial advisors indicate they expect more than double-digit growth in alternative assets under management in their respective practices.
• The main driver of growth in alternative investments in the next five years will be capital-protected and structured products, as predicted by 28 percent of advisors.
• Fifty-eight percent report that addressing portfolio correlation is the objective fueling the growth of alternative investments, followed by absolute returns with 49 percent.
• Approximately 44 percent of the open-ended responses indicate the accredited investor restriction is very relevant, while a substantial 33 percent of advisors indicated the restriction is not relevant today. Twenty-two percent of respondents said they are not sure about restriction or feel it is somewhat relevant. The open-ended responses were grouped as "relevant" if advisors said the current dollar-amount restriction is accurate or indicated that it is the best available means of screening investors. The open-ended responses were grouped as "not relevant" if advisors said the asset threshold for accredited investors is too low, the threshold can be circumvented, or it is not an accurate means of measuring investor accreditation.

Morningstar offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions. Morningstar provides data on approximately 145,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 13 countries and minority ownership interests in companies in three other countries.

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