The Issue Defined: As hedge funds gain wider acceptance in the wealth-management space, investment advisers struggle to determine how they fit into their clients' portfolios. And, without the appropriate tools to support retail clients' investment decisions, the confusion likely will continue.
Why It's Important: Despite recent efforts by regulators to increase transparency through the SEC's hedge-fund rule, hedge funds still don't report their financials the same way a public security does. The lack of industry information on hedge funds poses problems to both investment advisers and clients who wish to understand what's happening inside a hedge-fund product and how that product compares to performance benchmarks. Without the proper technology to do complex calculations and present information to investors in a comprehensible manner, advisers will be hard-pressed to convince clients to take action on these vehicles.
Where the Industry Is Now: According to consultancy Greenwich Associates, alternative investments are expected to increase at the expense of fixed income and domestic common stocks in the next three years. Hedge funds, which are approaching $1 trillion in assets, are clearly the hottest investment vehicle in the space; the hedge-fund market is on track to reach $4 trillion in assets by 2010. Advisers are only beginning to figure out how these products will fit into their asset-allocation engines, and clients who want to buy hedge-fund products still aren't sure where they fit into their portfolios.
Focus in 2005: The No. 1 challenge facing the alternative investment space - and hedge funds in particular - is establishing databases, indices and benchmarks, which is directly related to transparency. This year, the market likely will reward alternative-class investment managers who report their data frequently and offer some transparency to their portfolios beyond performance numbers. As more information becomes available, investment advisers will look to technology to provide more timely data to clients about these investments. The primary focus of advisers will be on monitoring and performance; as with other investment vehicles, if a hedge fund isn't performing, the adviser should redirect clients' funds to another product.
Who's Leading the Charge: Although it's still too early to name real leaders in the space, firms like Bear Stearns, Morgan Stanley and Barclays Global Investors offer robust platforms for alternative products. However, in terms of supporting advisers with the technology to incorporate hedge funds into portfolios, boutique shops like U.S. Fiduciary are gaining ground because they are able to integrate their systems from the ground up without having to retrofit siloed legacy systems.
Some Vendors in the Space: Well-regarded products include PerTrac, a collection and reporting platform by Strategic Financial Solutions (an online version is available at hedgefund.net), and Bear Stearns' Bear Measure Risk. RiskMetrics is recognized for its risk modeling.
Associated Costs: The estimated cost for an institutional-strength, fully integrated investment consultant platform that incorporates hedge funds and hedge fund of funds is $500,000 or more.
Industry Perspective: "It will take time, but hedge fund products, in terms of fees, definition and structure, will begin to look like building blocks that will actually fit into someone's portfolio. Your CIO at a pension plan is going to be forced to bucket the product so that he can manage its risk and return," says Elliot Weissbluth, president, U.S. Fiduciary Advisors. To accomplish this, he continues, "technology is necessary - you can't do this on Excel."