Advisor Insights

Alternative Funds Are in a Time Warp

Don Phillips

The gravitational forces that drive the rest of the mutual fund market—toward lower fees, more transparency, and better investor outcomes— seem not to apply to the alternatives part of the fund world. Despite much innovation and the emergence of credible new players, the alternative space looks more like the fund world of yore than the investor-focused fund world of today. In short, while the fund market as a whole has become a place driven by the demands of buyers, the alternatives space remains a seller’s market.

Four things must change to turn the odds more in investors’ favor and make alternatives a part of the mainstream fund world. First, fees must come down. The reality distortion field that has allowed alternative investors to charge higher fees despite their lower returns simply cannot last. How much longer will advisors who purge traditional active managers for the cost savings of index funds tolerate the inflated fees of alternatives, especially as the disappointing returns of many of these funds continue to accrue? The same math applies to all investments. If high fees undermine the attractiveness of active managers, higher fees must do even more to undermine the allure of alternative managers. The expectations of miraculous performances will diminish as disappointing investor experiences accumulate. Low costs cannot remain a factor that is worshiped in most of the portfolio, but ignored in another part. Vanguard’s continued experimentation with alternatives (one imagines to Jack Bogle’s horror) may prove a catalyst for this inevitable change.

Don Phillips does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.