Liquid alts' drawback: High cost

With relatively small number of firms in space, no need to compete on fees

Nov 16, 2014 @ 12:01 am

By Trevor Hunnicutt

The more alternative products that fund companies offer, the bigger the dilemma facing financial advisers.

For those who favor alternatives, managers are working to bring risk-diversifying strategies — long the exclusive province of big institutional investors and ultrawealthy individuals — into mom-and-pop-friendly mutual funds known as liquid alternatives.

But adopting those strategies may cost you. The difficulties of bringing products to market and increasing their size without sacrificing performance means that, as much as firms might like to compete, few seem to feel the need to compete aggressively on price.

“There's no Vanguard that's really dragging down the price,” said Morningstar Inc. analyst Jason Kephart. “Competition is still in the very early innings, so you don't have anyone who's established, like Pimco with bonds or Fidelity used to be with growth equity.”

So far, the popularity of funds with exotic investment strategies means boom times for the relatively small number of big money managers.

The top funds vying for attention in the space include bond behemoth Pacific Investment Management Co., the Natixis Funds roll-up of boutiques, the academically inclined AQR Funds and allocation-oriented John Hancock Investments.

Large firms such as BlackRock Inc., The Goldman Sachs Group Inc. and Invesco Ltd. have also been making moves to build out their lineup of alternatives funds.

Fund fees dropped nearly 5% to an average of 1.02% in 2013 from 1.07% in 2009. But alts charged 1.45% in 2013, down less than a percent from 2009, according to Lipper Inc.

Behind that are at least two areas in which supply is constrained.

First, managers with strong track records in niche strategies who will trade lucrative hedge fund fees for the lower revenue of a liquid-alts version are in short supply. And many of those strategies are limited in the amount of money they can take in without compromising performance.

“It's a space where there's a lot of demand but not a lot of managers that have time-tested and proven records,” said Andrew Arnott, president of John Hancock Investments, which has $8.6 billion in alternative assets. “There are certain types of strategies that are not on the platform today that we are considering that will have very specific and stated capacity issues going out the door.”


Second, the bandwidth of the broker-dealer gatekeepers charged with recommending funds to financial advisers is also limited. That creates advantages for firms that can invest in or “seed” those products in their infancy and gain a track record as well as an early share of assets.

“The bottleneck in the pipeline is due diligence — it always is due diligence,” Mr. Arnott said. “The stacks on the desks of the gatekeepers at these broker-dealers is high. There is a lot to work through.”

Matthew Coldren, who manages relationships with U.S. broker-dealers at Natixis Global Asset Management, said the research teams at those firms are cautious and “don't want to drop all these products on the platform.”

But those broker-dealers are not pressuring Natixis — which markets the funds of a set of affiliates, including Loomis Sayles & Co. — to lower its management fees, he said.

“That's completely up to us,” said Mr. Coldren, whose firm manages nearly $12.5 billion in alternative assets.

Alternatives funds held nearly $206 billion in the U.S. as of Sept. 30, up an eye-popping 764% from $24 billion a decade ago.

Despite that growth, the big firms in the category are struggling to differentiate their products, which fund managers complain are lumped together in overly diverse categories such as managed futures, unconstrained fixed income or long/short equity.


When the well-known $18 billion MainStay Marketfield Fund (MFADX) stumbled and broke its 31-month asset-gathering streak in April, investors across the board soured on long/short equity funds.

In the past two quarters, inflows slowed by nearly 83%. Funds registering outflows for the period rose 56%, according to an InvestmentNews analysis of Morningstar data.

Jason Ainsworth, head of the adviser sales business at Neuberger Berman Group, said long/short funds vary from those relying on macroeconomic predictions in picking companies to “short,” or bet against, to those relying primarily on “bottom-up” analyses of companies.

“We definitely still have difficulty in the field with clients and advisers saying, "I have long/short, and I've got it covered,' “ said Mr. Ainsworth, whose firm offers a fund that competes with Marketfield. “As you've seen some of the larger players struggle — given their unique style and strategy — flows have slowed.”

MainStay funds are managed by a subsidiary of the New York Life Insurance Co., which declined to comment.

The fact that alternatives can charge a premium is helping to finance industry best practices, according to Evan Mizrachy, who runs the retail business at the alternatives subsidiary of BlackRock, the world's largest money manager.

“The alternatives mutual funds require substantial investment in risk management,” Mr. Mizrachy said. “As more and more funds come to market, you'll start to see pricing get increasingly competitive.”


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