Hindsight is Everything: Why RIAs and BDs Need to Step Up to the Hedge Fund Plate Now

The Tradex Group Weekly Blog

May 6, 2013

By Richard Travia, Director of Research

Hindsight is Everything: 

Why RIAs and BDs Need to Step Up to the Hedge Fund Plate Now

“I think there is a world market for maybe five computers” – IBM Chairman Thomas Watson, 1943

Computers and mobile phones – the world as we know it today would not exist without them.  Yet it wasn’t that long ago that both of these ubiquitous yet essential devices were not available to the vast majority.  Price and availability kept the vast majority away.

That’s the way it has been with hedge funds…Available only to a small percentage of the investing public with a high barrier to entry, allowing only a small segment with access.

No more will this be the rule.  As an increasing number of high-net-worth individuals (HNWIs) and family offices are becoming more educated on alternative investments, hence demanding more from their financial advisors, registered investment advisors (RIAs) and broker dealers (BDs).  The onus of ensuring they get up to speed on picking the best offerings in this space is shifting to the advisors.  If these advisors don’t act quickly, they may risk losing their long-time loyal clients.

Many prominent wealth advisor platforms have already stepped up to the plate to make an initial foray into alternative investments, perhaps the most popular option being alternative strategies mutual funds, characterized as offerings in which mutual funds appoint hedge fund managers who act as sub-advisors to run strategies via separately managed accounts (SMAs).

Generally the strategies selected are more liquid in nature, with the majority being long/short offerings, along with global macro, managed futures and Commodity Trading Advisors (CTAs).  Often times, these so-called 40 Act portfolios onboard a collection of sub-advisors implementing a coterie of investment strategies under the premise that such diverse portfolios will mitigate risk.

Other times, they favor a sector-specific approach such as a CTA-focused alternative mutual fund where all underlying sub-advisors operate that specific strategy.  And finally, in less cases, although becoming more popular, 40 Act managers deem picking only one, or at most, two sub-advisors with a liquid multi-strategy investment strategy.

It is likely too early to tell whether 40-Act mutual fund strategies will accomplish the goal of diversifying investor portfolios while providing uncorrelated and absolute return streams.  In many cases, RIAs and BDs are experienced enough to intelligently determine whether a more traditional fund of hedge funds manager can better and more efficiently serve their clients’ needs.

A highly-regarded report from McKinsey & Company titled “The Mainstreaming of Alternative Investments: Fueling the Next Wave of Growth in Asset Management,” confirms the trend that alternatives have rapidly been moving into the mainstream US retail market as individuals confronted with volatile financial markets and retirement savings gaps have been expanding their investment repertoire, hoping hedge fund strategies would salvage their portfolios.

Many investment firms across the US who both historically and more recently manage alternative strategies mutual fund offerings have been major beneficiaries of this growing interest from wealth managers.  Already as a result of client demand, retail alternative assets, and alternative-like strategies such as commodities, long-short products and market-neutral strategies have grown by 21% annually since 2005 and now stand at $700 billion, or appropriately 6% of total US long-term 40 Act retail assets.  With the pending implementation of the JOBS Act and the rescission of the General Solicitation Rule, we expect to see increasingly strong demand in experienced hedge fund allocators. 

If more wealth managers don’t move to provide their HNWI clients access to alternative investments, they might risk losing their long-time loyal customers who will seek other financial advisors to gain access to such strategies.

“There is no reason for any individual to have a computer in their home,” Ken Olson, President of Digital Equipment Corporation, said in 1977.

Hindsight is everything.

Richard Travia serves as Director of Research of Tradex Global Advisors.  He is a Partner and co-founder of the firm, and he focuses on hedge fund manager due diligence and selection while also overseeing the R&D for Tradex’s systematic hedge fund identification models.  Headquartered in Greenwich, CT, and managed by partners Michael Beattie and Richard Travia, Tradex Global Advisors was launched in 2004 and today manages a single hedge fund and several fund of hedge fund portfolios.  Learn more about Tradex at http://www.thetradexgroup.com or follow Tradex on LinkedIn and Twitter.