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Growth Continues for Alternative Funds

For alternative mutual funds, 2012 was a mixed bag.

All told, funds that bet on assets other than stocks or bonds or on strategies other than simply buying and holding stocks or bonds for the long haul picked up $19 billion in 2012. Assets reached $150.6 billion altogether, compared to $126.1 billion in 2011 and $104.3 billion in 2010.

Specifically, $6.1 billion flowed into funds that bet both long and short on stocks, $5 billion into alternative bond funds and $4.2 billion flowed into "multi-alternative" funds which bring together a range of alternative assets and strategies.

But growth is tailing off. In 2011, the funds raised $24.4 billion and, in 2010, $45.8 billion, according to data from Morningstar. Nadia Papagiannis, Director of Alternative Fund Research at Morningstar, explained that total industry inflow is a combination of assets and performance. Meanwhile, there were 70 alternative mutual fund launches in 2012, matching the 2011 count and there were 12 fund closures.

Although investors were scared off by the gyrating equity markets, they knew they had to be in alternative equity funds according to Papagiannis. "They needed to hedge their investments in conventional funds in case there was a big collapse in the stock market after the presidential election in November or the U.S. economy went over the fiscal cliff, on January 1," she said.

Assets flowed into multi-strategy funds because "advisors know that they need to be in alts but they don't quite know how," said Papagiannis. In the meantime, she was a bit surprised by the amount of assets that flowed into alternative bond funds "given that the Fed said they weren't going to have rising interest rates for a while if they have anything to do with it."

On the flip side, market neutral funds, which balance bullish and bearish picks, ideally offer returns 3% to 6% above Treasury rates. These lost $561 million because of the low-interest rate environment. "So when cash is zero, it's hard for people to justify going into something that's going to give them only a couple of percentage points above cash," she said.

Papagiannis expects the number of launches could be greater than 70 in 2013. She said funds that came to market also were more granular as long/short real estate funds or emerging market credit long/short funds. In the managed futures space, single manager funds won over funds of funds.

Big firms such as Janus Capital Group and Fidelity Investments are either launching their own products, such as the Janus Diversified Alternatives Fund, which bets on stocks, bonds, commodities and currencies, or in the case of Fidelity, partnering up with hedge funds such as Arden Asset Management to manage alternative offerings.

"It's a win-win for both sides because traditional mutual funds don't have the expertise in-house so they have to outsource it and hedge funds don't have the sales and marketing capabilities that mutual funds do," said Papagiannis.

A new wrinkle in the alternative mutual fund landscape is traditional fund of hedge funds trying their hand at the '40 Act space. For example, Money Management Executive previously reported on international fund of hedge funds Grosvenor Capital Management's planned launch of its Grosvenor Alternative Strategies Fund this year. The offering will have exposure to activist strategies, whereby firms accrue large enough stakes in companies to be able to force corporate change.

"Individual investors have left funds of hedge funds because they don't want to deal with them any more and larger institutions have also left and are doing it themselves in terms of sourcing the managers," said Papagiannis. "So funds of funds customizing products for their clients or are going into the mutual fund space."

But the traditional hedge fund of fund fees, which charge investment advisory fees and incentive fees on top of the underlying managers' fees, may be a big deterrent to investors. "If the provider and the distributor don't want to come down on their fees, then the end result is going to be a product that nobody is going to look at," she said.

Dick Pfister, managing director, of Global Sales and Consulting for Altegris, which manages five alternative mutual funds of funds, said it's not apples-to-apples when comparing his fees to other single managers' fees. "When we look across our mutual funds, our fee is about 1.5%. Hedge funds of funds have an advisor fee and charge an incentive fee over and above the underlying managers' fees," he said.

"So we price our funds to be 50 to 100 basis points cheaper than our private placement competitors. But when you put this into a mutual fund format, people are comparing it to single managers who are doing a replication strategy because they look like they're egregiously high,'' he said. "This is the education process that our wholesaling team has to go through with advisors."