More brokers look to ETFs to replace hedge funds

By Aaron Pressman

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 towards 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 (135.4 billion pounds) 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.