There's no question that asset management firms are interested in moving into this space. Fully 100% of U.S. participants in McKinsey's survey said they believe alternatives will grow faster than traditional assets. Moreover, they can be expected to earn more on these assets than traditional products. Retail alternative investments can generate two to three times greater revenues than traditional mutual funds. Indeed, alternatives will account for a majority of retail revenue growth by 2015, according to McKinsey.
Still, alternatives present challenges not only for asset management firms, but for investors and financial advisors. One of the biggest challenges is integrating alternatives into traditional asset allocation models. Instead of allocating long/short hedge fund strategies to an alternatives category with illiquid real estate, for example, institutional investors increasingly group such investments with public equities. "It's not very intuitive," said Erzan. "This is an important opportunity for the industry to help investors map alternatives to standard approaches."
Equally challenging is communicating the value, risks and strategies of these investments to clients. "Some of the underlying strategies are sophisticated and you have to be able to communicate to clients without confusing them," noted Erzan.
The challenges for traditional players in the asset management industry are no less daunting. Many institutions and financial advisors are unwilling to allocate assets to managers who do not have an established track record-often, three years of performance. Asset management firms looking to take advantage of the growing demand for alternatives in the near term have little choice but to buy alternatives specialist firms or lift out specialist teams with established track records, said Kurt MacAlpine, associate principal at McKinsey and co-author of the report. Firms with a longer time frame can choose to build the expertise and track record, although there's no guarantee that will work, he noted.
Moreover, once such a team is in place, traditional firms face additional questions. How do these teams coexist with traditional asset managers who are compensated quite differently? How does the firm leverage the team's expertise to introduce new, integrated products? And, how do these products fit into the firm's existing sales process and capabilities?
Despite these challenges, investments in alternatives are expected to continue to grow strongly. Investment management firms will continue to be attracted by the opportunity to diversify their businesses and generate higher revenues. As far as financial advisors are concerned, said Erzan, alternatives provide "a lot of opportunity" to help clients navigate today's tough markets.