Due to the combination of bruising market losses, high correlation among asset classes, unexpected illiquidity and epic scandals, the investment management industry faces a restless, empowered investor base.

In addition to a focus on transparency and liquidity, retail investors and their advisors – as well as smaller institutional investors – are increasingly focused on absolute returns and investment strategies uncorrelated with long-only equity and bond indices.

Consequently, asset allocation trends are accelerating demand for products that combine access to non-correlated strategies and asset classes with the liquidity and transparency of registered investment products.

With more than 50 per cent of European hedge fund managers planning to establish Ucits products, the number of alternative Ucits (or Newcits) offered will continue to grow. Ucits attracted inflows of USD35bn into hedge fund-like strategies, absolute return benchmarks, commodity exposure, and other non-traditional approaches in 2009, and currently total more than 1,000 funds with USD200bn in assets. As hedge fund managers adopt retail distribution best practices and as comfort levels grow, we see some emerging as robust competition for traditional products.

However, while the industry welcomes a broader selection of innovative strategies in a regulated and retail-available vehicle, the possible damage to reputations if they fail to deliver is of concern.

In addition, not all strategies fit within the Ucits format, and firms must first determine whether offering an alternative mutual fund fits their branding and long-term strategy. There also are several other factors that need to be addressed: filling any gaps in skills and expertise, regulatory considerations, operational considerations and distribution considerations.

To be successful selling Ucits, firms must have an educated sales force and the infrastructure necessary to support advisor and investor education effectively. Firms should also position their strategies first as diversification tools and second as alpha generators, since our research shows that investors generally use alternative strategies primarily for diversification purposes. Traditional firms, leveraging their existing distribution relationships and advisor support infrastructure, have had the greatest success to date.

Demand for alternative or non-correlated strategies in European Ucits is real, as reflected by net inflows into existing products, the growing accommodation of such strategies in model portfolios of intermediaries, and increased investor demand for a broad set of diversification tools.

Given their experience in educating investors and advisors and their existing distributor relationships, we believe that traditional fund managers will continue to enjoy the most success in the retail alternative fund business in the near term.

Initially, alternative managers’ best opportunity may be to sub-advise or partner with an existing retail manager. Such an approach can also be a win for traditional firms that might lack the requisite investment skill or expertise.

Phil Masterson is head of SEI’s Knowledge Partnership Program, which provides ongoing business intelligence to SEI’s investment manager clients

Download the full Hedgeweek Special Report on Hedge Funds Regulation UCITS 3 2010