While hedge funds remain popular with ultra-high net worth investors, those with relatively less wealth are looking beyond traditional limited partner funds with high fees and percentages and limited liquidity and transparency.

“Hedge funds are not going away, but we are seeing a trend toward more liquid alternatives,” said Gary Carrai, senior managing director for outsource platform provider Fortigent.

“We’re seeing more mutual funds structured in a way that look and feel like a hedge fund only with daily liquidity and more transparency. There are now long/short funds that are not limited partnerships but separate accounts so investors know what’s happening with trading, and can get around the Madoff issue, so to speak," Carrai said.

“It’s philosophically important for us to retain liquidity and be able to get out of things if they go bad,” said Norm Boone, president of San Francisco-based Mosaic Financial Partners.

Boone said he has shied away from putting his clients in traditional hedge funds and instead considered other options, including mutual funds, individual securities, commodities and real estate funds. .

Open-ended mutual funds with hedge-fund characteristics, fund of funds and exchange-traded funds appear to be the most popular replacement for traditional hedge funds in wealth managers’ portfolios, managers said. .

Mutual funds

In fact, in a recent survey of financial advisors by the Boston-based research firm Aite Group, nearly one-quarter of advisors surveyed said they expect mutual funds to gain the most as a percentage of their assets under management in the next three years, and 13 per cent cited exchange-traded funds.

“We’re seeing ETFs getting traction and gaining in popularity as investors demand liquidity and see how hedge funds have been performing,” said Alois Pirker, research director for Aite Group.

“Investors are re-thinking the size of their commitment to hedge funds,” said Stephen Cucchiaro, president of Boston-based Winward Investment Management.

Cucchiaro cites Winwards’ 30 per cent-plus gains in assets under management  in 2008 and 2009 as evidence, bringing the firm’s assets to over $3.6 billion.

“Investors and wealth managers who  want liquidity are looking for alternatives and see firms like ours as a solution,” Cucchiaro said. “We have a globally diversified strategy using ETFs that has been very successful.”

ETFs are also being employed more by multi-family offices who have become more concerned with liquidity after the market downturn, and as transferring generational wealth becomes an issue, said Mark Wickersham, senior associate for Family Office Metrics in Boston.

“They like the fact that they’re cost-effective and can be sold when the families need to sell,” Wickersham said.

Even ultra-high net worth investors, who have stayed loyal to traditional hedge funds, are now “willing to have conversations about ETFs,” said  Stephen Horan, head of private wealth management for CFA Institute in Charlottesville, Virginia.

“It’s in the context of a core-satellite strategy,” Horan said, “and those investors are now comfortable with ETFs in their core holdings.”

So-called “replicator” or “tracking” funds  that try to reproduce hedge fund strategies at a much lower price are also seen as emerging alternatives to fill the void left by second thoughts about traditional  hedge funds.

Industry expert Bruce Lipnick, chief executive of Asset Alliance, an investment firm that specializes in acquiring, seeding and growing hedge funds, said in a recent interview with Finalternatives that over the next five years he expects to “see more ‘tracking funds,’ or funds that mimic a basket of hedge funds.”

No matter what investment vehicles are being used to replace hedge funds, investors - and wealth managers - are being driven by concern about risk, said Ira Rapaport, chief executive of Private Wealth Advisors of Wellesley, Massachusetts.

“In this environment, we are looking for tools and solutions to further diversify a client’s portfolio to have non-correlated investments,” Rapaport said.