Why Hedge Funds Are Going Mainstream

Financial section of newspaper
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Financial section of newspaper

The rich may not be so different after all.

After decades of investing in exclusive hedge funds, America's super rich are getting company as alternative investments are joining the investment management mainstream, a report from McKinsey & Co. released to clients in July showed.

"The new twist is driven by three major trends," said Kurt MacAlpine, an associate principal at McKinsey, noting that changes in how the products are structured, financial advisers' new tastes for them and changes in how they are accounted for in portfolios are all fueling demand.

Consultants at the firm forecast that retail alternatives, including hedge funds, will likely make up 13 percent of U.S. retail fund assets and about one quarter of revenues, by 2015.

That would be roughly double the figures from 2010, when retail alternatives made up 6 percent of U.S. retail fund assets and about 13 percent in revenues, the consultants found in their report entitled "The Mainstreaming of Alternative Investments 2012."

Until now, hedge funds have been reserved mainly for wealthy private investors who can afford their multimillion-dollar minimums and institutional investors like state pension funds.

But in the wake of the financial crisis, tastes are changing as average investors realize they need different investment options to make up for the money they have lost and perform well in uncertain markets going forward.

At the same time, asset-management companies are realizing that so-called alternative mutual funds could become a new cash cow as the firms can earn far larger fees on these kinds of portfolios.

The trend of offering these types of portfolios that pack a little more punch is already visible with many rolling out their new products. Earlier this month, renowned buyout shop Kohlberg Kravis Roberts joined the club when it applied for permission to launch two new funds.

Brad Alford, whose Alpha Capital Management has offered its Alpha Defensive and Opportunistic strategies for more than three years, said he began "betting this evolution would occur" years ago. The McKinsey report "clearly outlines one of the biggest opportunities in the asset management industry in our lifetime," he added.

But the consultants also found that many asset managers are not ready for the changing trend, acknowledging they are "unprepared for the shift."

To better prepare, they need to ramp up both risk-management and sales capabilities, the consultants found.