Welcome to Financial Advisor IQ

Dispensing Better Alternative-Fund Advice

August 29, 2014

In searching for a way to separate full-service advice from the pack, one area that appears ripe for the picking is so-called “alternative” mutual funds. They’re white hot these days, not only with FAs but also with mainstream investors.

Still, in the past three years only slightly more than a third of the $58 billion invested in such funds has gone into the coffers of managers offering the lowest fees, according to Morningstar Advisor. By comparison, the website finds an overwhelming majority of inflows into mutual funds as a whole go into bargain-basement fare.

The relative newness of alternative funds can make sorting through a still-evolving and growing field rather confusing for the uninitiated, the article says. Also, Morningstar Advisor sees a lot of “performance chasing” behind the numbers, fostering “less attention to fees.”

This lack of focus can be critical. Morningstar’s data show that most of the mutual funds it ranked as attractively priced were able to outperform from 2008 through 2013. While a typical alternative fund’s fees have been trending down a bit since 2011, Morningstar Advisor finds they’re still pricey compared to the broader universe.

Still, there are rays of sunlight for advisors who are bullish on alt funds — which typically incorporate some sort of hedging strategies. For one thing, Morningstar Advisor says several managers have been trimming the fat on fees. The website lists absolute-return funds run by John Hancock and Neuberger Berman as prime examples. A possibility for those with institutional clients is Vanguard’s Market Neutral fund.

The common rationalization for the high price tags on alternative funds is that they’re still cheaper than hedge funds in the wild, so to speak. But this logic shrivels as more alt funds come into the marketplace, says Morningstar Advisor. And this is probably good news in the long run for investors who want affordable diversification.

By Murray Coleman
  • To read the Morningstar Advisor article cited in this story, click here.