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The Alternative Fix

As alternative investments take on the marketplace, firms search for the right tools to support the trend.

Alternative investments are gaining broader acceptance in the wealth-management industry. A recent study by Rye, N.Y.-based Tremont Capital Management showed that hedge funds alone pulled in more than $100 billion in the first nine months of 2004 as institutions and high-net-worth investors looked for alternatives to traditional stocks and bonds.

As financial-services firms face an increasingly competitive market, more and more institutions are offering non-traditional investments like hedge funds, commodities and futures to satisfy the wishes of their investment-savvy clients. "The investor is looking for a financial institution that can provide various levels of investments depending on what their wealth is, and the only way for an institution to be able to do that is to actually provide alternative investments for the client," says Isabella Fonseca, a senior analyst at Celent Communications in Boston.

Competitive pressure isn't the only force driving firms to provide alternative investment products. At a recent wealth management conference hosted by Wall Street & Technology in New York City, industry panelists agreed that less volatile alternative investments can mitigate risk and provide better returns than some traditional investment offerings. But as alternative investments become a more viable option for investors, their advisers are faced with some unique technological challenges.

Finding an Index

When Advest, a Hartford, Conn.-based investment advisory firm, wanted to include alternative investments in its asset allocation engine, it ran into some serious roadblocks. "Just from a technology perspective, alternatives create a lot of problems because they're hard to index," says John Wellington, director of wealth management and advisory services at Advest.

Advest's asset allocation engine, a customized version of AdvisorDecide by White Plains, N.Y.-based Informa Investment Solutions, is index-based. When it came to alternative investments, the firm's advisers were hard-pressed to find an appropriate index because they couldn't run the engine based on individual securities' performances. Instead, says Wellington, Advest had to create one. "We offer two types of alternative investments: managed futures and managed commodities," he explains. "A commodities alternative investment has a very different characteristic than a financial futures alternative investment, yet because of simplicity we could really only offer one index in our asset allocation engine, so we had to blend those two things together."

Advest turned to Chicago, Ill.-based Ibbotson to blend equal parts of a financial-futures alternative investment index and a managed-commodity alternative investment index. The index blend is currently used in Advest's asset-allocation engine and enables advisers to raise the issue of alternative investments with clients. They use the new index to show clients the benefits of alternative investments in an asset-allocation scheme and give them some representative performances with regard to adding alternatives.

Although using a blended index is the most economical solution for firms like Advest that only provide alternative investments to high-end clients, Wellington admits there is a better solution. "The most ideal [solution] would be to have six different alternative indices in the asset-allocation engine, so you can pick the one that's much more specific to the actual investment you put the client in," he explains. But he adds that purchasing six separate indices and dedicating so many resources to an asset class that represents only a small portion of Advest's revenue just wouldn't make sense.

Gathering Accurate Research

US Fiduciary Services, a Sugar Land, Texas-based firm with over 200 advisers, is working with a bigger budget. The firm currently has a $3 billion turnkey asset-management platform that combines its Vista Analytics business with its West Hills institutional business. It's now completing an alternatives platform that will provide its advisers with research on the performance of alternative products, allowing them to offer their clients a wider selection of investment vehicles.

According to Elliot Weissbluth, president of US Fiduciary, advisers who work at wirehouses typically can't offer advice on an alternative investment product unless it's on their firm's approved list. Since most firms want to control the products their advisers sell to avoid liability and turn a profit, those lists are usually small. Instead of examining new alternatives to add to that list, advisers are encouraged to offer clients pre-approved products. With US Fiduciary's new alternatives platform, Weissbluth claims its advisers won't have that problem. "We don't make money on the products we recommend," he says.

The platform works like "an old-fashioned service," Weissbluth says. An adviser can ask an in-house research group to look into any product. The research group then compares that product to similar products in the marketplace. Advisers and their clients are also given a clear view as to how the product was analyzed and how its performance was measured. Weissbluth says that setting the proper framework for comparison is crucial as some hedge funds are more volatile, producing relatively higher returns, and others have lower volatility, producing relatively lower returns.

Weissbluth says that US Fiduciary Services' alternative-investment platform will be fully functional by March 2005. The information on hedge funds has come mainly from the manufacturers themselves, and the firm hopes to offer advisers an unbiased point of view.

The Road Ahead

Advances are being made in the alternative-investment realm, but, ultimately, the big issue facing the alternative-investment industry is getting databases, indexes and benchmarks straightened out. "If you want to know how an equity manager performs ... you buy the S&P's data set in confidence that it's a good set of data," explains Weissbluth. In the hedge-fund space, although there are a handful of well-regarded data providers like HFR, TASS and MARHedge, none of them fully represents the entire hedge-fund universe. Since hedge funds currently do not have any reporting requirements - the SEC hedge fund rule does not take effect until February 2006 (see related story, page 38) - the databases, even when consolidated, are missing out on some of the best hedge funds.

"The underlying problem with any of the technology solutions is that we're still figuring out how to get an accurate data set," Weissbluth says. "You can buy all the analytical tools in the world, but you need to have some universe of data that you have a high degree of confidence that it makes sense."

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