Institutions, Advisers Agree Somewhat about Alternatives

The survey, conducted by Morningstar, Inc. and Barron’s, found that “both institutions and advisers want alternative investments that are liquid, transparent, and regulated like traditional investments,” said Steve Deutsch, director of separate accounts and collective investment trusts at Morningstar.

Survey respondents, asked to identify the top three reasons to hesitate to invest in alternatives, cited:

• lack of liquidity (54% institutions; 53% advisers)
• lack of understanding (45% institutions; 46% advisers)
• lack of transparency (45% institutions; 34% advisers)

“This demand is driving the convergence of traditional and alternative money management. We’re seeing more alternative investment strategies in mutual funds and ETFs, higher prevalence of retail and alternative money managers competing for assets under management, and traditional money managers acquiring, merging with, or recruiting alternative investment expertise.’

A third of institutional investor respondents thought that alternative investments would become as important as traditional investments over the next five years, while 17% thought they would become somewhat more important, and 13% “much more important.’ On the other hand, nearly a quarter thought they would become much less important (13% said somewhat less important). Advisers showed similar but slightly lower importance predictions (27% as important; 13% somewhat important; 12% much more important).

Other Findings

Among the survey’s other findings:

• Limited partnerships, including hedge funds, direct real estate, and private equity, are the most popular alternative vehicles for institutions.
• Almost half of institutions surveyed allocate more than 10% of their portfolios to alternative investments, and nearly one-in-five allocate more than a quarter of their portfolios to alternatives.
• Institutions generally expect their portfolio allocations to alternative investments, particularly hedge funds and private equity, to increase over the next five years. In fact, close to a quarter (23%) of institutions expect to invest more than 25% of their portfolios into alternatives.
• The survey also noted that the “previous excitement seen over 130/30 and all manner of leveraged net-long investment strategies appears to have diminished.’ In fact, more than 70% of institutions expect assets invested in leveraged net-long strategies to remain unchanged in 2009.

The survey results showed that advisers and institutions both agree and disagree on what is and isn’t an alternative investment. According to Morningstar, institutions have a more pronounced view of what is and isn’t an alternative investment. When asked what defines alternatives, respondents said:

• Infrastructure (77% advisers, 83% institutions)
• investments linked to natural resources (82% advisers, 86% institutions)
• managed futures (84% advisers, 87% institutions)
• private equity/venture capital (88% advisers, 94%, institutions)
• hedge funds (89% advisers, 96% institutions)

Other alternative categories for institutions include: distressed debt/mezzanine debt/distressed equity, volatility, carbon emissions, swaps (interest, credit), and socially conscious/responsive stocks. Other alternative categories for advisers include: equipment leasing; oil and gas explorations (limited partnerships); angel investing, mezzanine debt, bridge loans; promissory notes, private mortgages, tax liens, private debt, private placement life insurance; viaticals; and church bonds, municipal arbitrage.

• As for which categories might get increased allocations over the next five years, institutional investors cited:
• 25%—hedge funds
• 18%—private equity/venture capital
• 10%—other
• 7%—capital protected/structured

Distinctly not “alternative’ in the opinion of survey respondents were:

• REITS (71% of institutional respondents said these were not “alternative’ investments, compared with 55% of advisers)
• emerging market bonds (79% institutions, 73% advisers)
• treasury inflation-protected securities (80% institutions, 75% advisers)
• emerging market stocks (79% institutions, 76% advisers)
• international small caps (88 institutions, 81% advisers)

Morningstar and Barron’s conducted the Internet-based survey in October; 252 institutions and 1,180 financial advisers participated.

Further survey results, including charts, are available at global.morningstar.com/2008Alternatives.