Salient to Investors:

There are more than 400 liquid alternative, hedge-fund-like strategies offered in a mutual fund wrapper, up from a few dozen prior to the financial crisis.

Many observers think it unlikely that equity returns will continue to be as robust as the last 5 years, while bonds face the well-known risk of rising interest rates.

Christine Johnson at Deustche Asset & Wealth Mgmt said alternatives are not going to keep up with a bull market and while they reduce volatility, they are not a yield replacement. She likes long/short equity for aggressive clients.

The Morningstar MSCI Composite AW Hedge Fund Index rose less than 5% through September 30, 2013 versus almost 20% for the S&P 500.

Nadia Papagiannis at Morningstar said alternatives should be used to reduce risk and volatility and not to chase returns, so are more suitable for more risk-averse investors, while younger investors who don’t need to worry about liquidity could benefit from the more illiquid strategies, such as private equity or private real estate, because of their long investment horizons.

She prefers strategies that are hedging volatility, such as long/short equity funds that buy puts to protect the downside. Papagiannis said that nontraditional bond funds tend to take on a lot of credit risk and are therefore vulnerable if the stock market falls.

Philip Roberts at Round Table Services said funds of funds give you immediate diversification. Morningstar said the average expense ratio of such funds is 1.85%. Roberts prefers merger arbitrage strategies.

Glenn Myers at The MDE Group said we are at the end of 30 years of falling interest rates, so we need creative ways to control volatility and get returns without relying on a large allocation to fixed income.

Natixis Global Asset Mgmt found that only 25% of advisers said they regularly use alternative investments, while 75% don’t primarily due to a lack of understanding.

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