BOSTON (Reuters) - As wealthy investors stream out of hedge funds this year, Wall Street is trying to lure them back with a much simpler product: exchange-traded funds.
Most of the new programs, like one introduced by Barclays Wealth last week, use active managers who allocate clients’ money into various passive index-based ETFs. By relying on ETFs, which can be easily bought and sold at a moment’s notice, participants may avoid problems experienced by investors in hedge funds that barred them from withdrawing money last year.
That hedge funds can be illiquid and unpredictable was an important lesson from last year’s market meltdown, said Andrew Lo, director of MIT’s Laboratory for Financial Engineering.
The ETF-based programs are “perfectly consistent with the drive toward better diversification and great liquidity,” he said.
Traditionally, Barclays and other firms allocated wealthy clients’ money among private money managers, hedge funds and other exclusive products. But with the proliferation of ETFs of all varieties — and the poor performance of many high-priced money managers during last year’s turmoil — simpler products are gaining in popularity.
“There are a lot more ETFs in different asset classes than they had been in the past, and they’re becoming more nuanced,” said Sean Crawford, portfolio manager of the new strategy at Barclays Wealth, which oversees $221 billion for clients. “It’s become a pretty compelling investment idea.”
There’s plenty of money waiting on the sidelines for a better investment mousetrap. As markets crashed last year, investors became increasingly disenchanted with hedge funds. They pulled about $800 billion out of such investments between July 1, 2008, and June 30, 2009, according to research firm HedgeFund.net, which tracks the industry.
In the third quarter, investors finally began adding more than they withdrew, but net inflows totaled just $42 billion, less than half the quarterly amounts in 2007.
Another attraction for the wealthy is the far greater degree of transparency that ETFs offer. At any time, investors can see exactly what’s in their accounts, a far cry from hedge fund managers who keep their portfolios secret.
“You’re never really sure what you have with a hedge fund,” says Brian Bruce, director of the Alternative Asset Management Center at Southern Methodist University’s Cox School of Business. “Now people want more transparency — it’s a move away from hedge funds.”
Still, ETFs are not a panacea for everything that went wrong last year. Investors may be disappointed if firms’ asset allocation models go astray.
And the programs will not catch on if many of the wealthiest clients continue to prefer more exclusive private money managers, Bruce said.
“When you’re running a program based on ETFs,” he said, “you aren’t giving that high-touch feeling that high net worth folks really crave.”
So far, Barclays is one of the largest firms to introduce a high-profile ETF-based program. At some of the largest firms, like Morgan Stanley (MS.N), some individual financial advisors incorporate ETFs into investing strategies. UBS UBSN.VX says it offers some ETF-only programs among its more than 100 asset allocation programs, but doesn’t use any leveraged funds.
The program has attracted about $2.5 billion, according to Genworth Senior Vice President Michael Abelson, who said the market turmoil over the past year had a growing number of investors clamoring for asset allocation solutions.
Barclays Wealth started with an ETF-based approach in Europe in August 2008. It had attracted 200 million pounds by June.
ING and MetLife (MET.N) have introduced similar programs in the form of mutual funds and annuities aimed at more mainstream investors.
Barclays said its new program would use ETFs from any provider. In June, its parent, Barclays PLC (BARC.L), agreed to sell its asset management division, including the popular iShares line of ETFs, to BlackRock (BLK.N) for $13.5 billion.
Reporting by Aaron Pressman; Editing by Lisa Von Ahn