Investor snob appeal spurs exotic investment demand

For a growing number of financial advisers, the hot dogs and hamburgers of investing no longer satisfy.

They increasingly prefer more exotic fare, such as an occasional filet or even a little pate de foie gras.

That’s the gist of the new study of intermediaries scheduled for release today by Financial Research Corp, a Boston research firm. The study says advisers simply want to offer more to clients than a staple diet of plain vanilla mutual funds.

Industry watchers generally attribute the demand for alternative products to a desire for tax efficiency or portfolio customization, which mutual funds can’t always provide.

But one of the main reasons is the nation’s growing wealth and a desire among rich investors to have all the trappings their money can provide – including sophisticated investments.

“There is an exclusivity and a snob appeal associated with alternative products,” says Burton Greenwald, a financial services industry consultant based in Philadelphia.

“You’ve got some people who consider themselves wealthy, and they want bigger and better products.”

Lacking cachet

The FRC survey of brokers and advisers across the financial services industry suggests that intermediaries are eager to look beyond mutual funds and individual securities when they create investment portfolios for their clients.

Topping the wish list of alternatives were separately managed accounts, exchange-traded funds and hybrid wraps that combine both mutual funds and individual securities.

But other alternative products, such as hedge funds, private equity, customized stock baskets and managed futures were also ranked high in adviser interest.

Independent financial advisers expressed the greatest interest in separately managed accounts, exchange-traded funds and hedge funds, according to the study.

While mutual funds still account for 49% of all intermediary assets under management, the traditional mutual fund lacks the cachet of other products, says D. Chris Brown, FRC’s vice president of research and co-author of the study.

“Mutual funds are a given in a lot of portfolios,” he says. “People will use them, but it isn’t going to be enough.”

Mr. Brown adds that as client accounts grow larger, advisers are often pressured into enhancing the asset allocation models with products designed for rich people.

“For a lot of traditional money management firms, the thought process will have to broaden out to beyond just a new flavor of mutual fund or another bell or whistle on a variable annuity,” says Mr. Brown.

“They will need to think of themselves as investment managers that can package products in a number of different ways.”

Recognizing that basic equation, a number of financial services firms are rushing to expand their businesses with products and services aimed directly at wealthy investors.

SEI Investments Co., based in Oaks, Pa., plans to roll out a new hybrid wrap program at the end of March that will package separate account management with mutual funds in a fee-based product that will be sold by brokers and advisers.

Robert Aller, an SEI senior vice president in charge of the new managed accounts, says the company got the idea after watching advisers purchase SEI mutual funds and then go elsewhere for separate accounts.

“Clients, and the industry in general, are ready for this,” Mr. Aller says. “People are outgrowing mutual funds.”

With a 60% increase in mutual fund sales this year, says Michael Cemo, president and CEO of Aim Distributors Inc. in Houston, his company recognizes the growing demand for separate account management.

The company has responded with the creation of Aim Private Asset Management.

In the past few weeks, Aim signed agreements with First Union Corp. and PaineWebber Inc. to offer separate account management through the bank’s and wirehouse’s financial planners.

“I’m not even sure we’re offering investors anything better than mutual-fund wraps, but some people will prefer the separate accounts,” Mr. Cemo says. “This is the wealth factor; the middle and upper markets do have a bias toward a customized account.”

Even MFS Investment Management, the Boston-based company credited with launching the very first mutual fund in 1924, is developing ways to leverage its expertise to offer a few alternatives.

Bill Taylor, senior vice president in charge of private portfolio services, says MFS is creating a new division that will enlist the company’s “A-team money managers” for separate-account services. It will be offered through intermediaries.

The MFS program is starting with three investment styles — large-cap value, large-cap growth and large-cap core equity — but will eventually include up to eight different styles, Mr. Taylor says.

variety of ventures

“We are committed to the intermediary, and many of our best customers said they were moving their business to fee-based and away from mutual funds,” he says. “This is just another way of providing our investment expertise to the marketplace.”

Other notable examples include the new joint venture between investment bank Thomas Weisel Partners and Scudder Kemper Investments Inc. They intend to offer private-equity investments starting at $25,000.

And last year, Thomas H. Lee & Co. teamed up with Putnam Investments to leverage Putnam’s distribution and Lee’s private-equity management capabilities.

Nancy Fisher, a Putnam spokeswoman, says Putnam is also looking to create alternative products for retail investors who are unable to meet high minimum investment requirements.

Meanwhile, not everyone is on the same page when it comes to enhancing asset allocation models with non-traditional products.

Mr. Greenwald, the financial services consultant, says it is “scary to see the increased demand for these riskier and less-liquid investments in the wake of history’s greatest bull market.

“I think the fund companies are responding to some pretty high demand for new products,” he adds. “Whether that demand is well founded or not is another story.”