The Boglification of alternatives

When it comes to alternatives, investors are finding out what John Bogle knew many years ago: You get what you don't pay for. A majority of financial advisers and institutions now view fees as the main reason to avoid alternatives, up from 38% and 39% respectively in 2009, according to Morningstar Inc. and Barron's 2012 alternative investment survey. Liquidity and transparency were the top concerns in the previous four surveys. Managed-futures mutual funds felt the brunt of advisers' fee wariness. For the first time in three years, the trend-following strategy wasn't ranked as the top alternatives allocation strategy. In fact, it didn't even make the top five. Managed-futures funds are among the most expensive alternatives funds. The average fund charges 2.6%, according to Morningstar, and many have complicated performance fees attached to them as, well. To be fair, it probably wasn't just the fees that scared advisers away — the performance has been terrible. The average fund lost 7.4% last year and 6.9% in 2011. Managed futures did lead in terms of how many funds were launched last year. The 22 new entrants were the most of any fund category, while the multialternatives category was second with 17 launches. Institutions, meanwhile, were busy ditching long/short hedge funds for long/short mutual funds, with costs a key driver, said Morningstar analyst Nadia Papagiannis. “Institutions are finally realizing the cost of hedge funds, including fees, lack of liquidity, lack of transparency, and lack of regulation, are starting to outweigh the benefits,” she said. More than 45% of institutions use long/short equity mutual funds, up from 38% in 2010, while just 26% report using long/short hedge funds, down from 61% in 2010, according to the survey. The good news is that the more institutions latch onto alternative mutual funds, the better it will be for advisers, Ms. Pappagiannis said. “It lends more credibility to alternative mutual funds,” she said. “It'll bring attract better offerings. More assets should theoretically mean lower fees, too,” Ms. Papagiannis said. The average long/short mutual fund charged 1.9% last year, according to Morningstar. That's just under the 2% that most hedge funds charge and doesn't have attached to it a performance fee, which can typically be about 20%.