A growing number of fund firms want to tap into booming investor demand for yield and income by developing a variety of new alt products that would strike advisor fancy.

But how do you come up with new product ideas? How do you educate advisors on the advantages, and disadvantages, of alts?

If you're John Cadigan, managing director and national sales manager at Arrow Funds [profile], you combine both wholesaling with product brainstorming into a single process he calls "rationalization."

At its base, Arrow's rationalization process involves plenty of conversation between Arrow sales execs and clients, and potential clients, over their "pain points" and the kinds of products they'd like developed.

This process was instrumental in a number of Arrow creations such as the Arrow Dow Jones Global Yield ETF [SEC filing], and the S&P 500 Equal Weight ETF (Ticker:RSP). While RSP is a Guggenheim fund, many former Rydex executives, who later went on to found Arrow, were behind many of the innovations behind the fund's strategy.

Cadigan describes the rationalization process in this way:

Listen to the market. It starts with understanding our partner firms' economic outlook, asset exposure recommendation and the intent of those exposures. Is there an opportunity to provide an asset class they can’t find exposure too or is there a better construction that they would prefer – back to the RSP and GYLD equal weight discussion. It can vary based on firm. Some ETF managers have different management approaches and  nuances based on how they execute allocations decisions vs. traditional B/D/RIA’s allocation decisions  Start at the strategy level and then discuss what structure the firms would like to implement – fund vs. ETF etc.

For example, Cadigan says that the GYLD ETF "was developed due to increased demand to move away from domestic based income – huge diversification globally equity and  fixed income and alternatives."

Cadigan says he and his colleagues target a number of different groups with this process, including the larger RIAs, ETF managers, traditional B-D home offices and financial advisors.

"It is everyone's collective responsibility to pay attention as you never know where your best new idea will come from," he said.

What are the steps involved? Cadigan says it differs depending on the audience, but there were some general principles to how they conduct the dialogue:

Depends on the audience but the simple answer is through open dialogue that involves your client or prospect outlook and approach based on  various market theories. Are they classic MPT, do they ascribe to momentum as a factors are they dynamic allocators.

At the B/D home office level it can be asset exposure or strategy exposure that can fit into an allocation model that blends traditional asset mixes with alternatives to improve on the risk/return metrics of the portfolio. Increasingly we are hearing of about providing strategies that fit into, for instance, an all alternative sleeve.

The process requires a final beta test – can we find enough demand for  a strategy or is it a one off? If we can’t scale it you have to question the viability. Is the request forward thinking or after the fact? We want to catch the trend before it happens. For instance RS Momentum has been out of favor and no one wants to look at it as factor but if you look historically now is the perfect time to gain access for the coming years. We have an academic piece to support why now.

It starts with what is the end game – our outcome investing. What are their models our what strategies do they want to provide the end clients? Over the past decade the conversations really have involved the path dependency nature of investing. What I mean by that is simply how can we help better construct portfolios that mitigate large drawn down potential. Advisors and their clients tend to look at strategies based on annualized returns streams yet few invest on Jan 1st and exist Dec 31. What truly matters in what is their entrance point and exist points? No one can time the market but if we can help construct a strategy that can limit tail risk when allocating the better off the client is. It’s upside vs. downside capture. The really big questions are how can you help provide nontraditional income options?

The strategy is an outgrowth of the sales philosophy of Skip Viragh, the founder of Rydex Funds. Many Arrow executives are former Rydex veterans, including Cadigan, who worked at Rydex for 12-years and served as managing director and national sales manager. Many of these same veterans were the brain-power behind many of Rydex's innovations.

It was all founded on a simple principle – listen to your client. It’s part of Arrow’s DNA as a consequence since 90% of the firm is former Rydex’s. My favorite quote from Skip was “if you’re not bringing in assets you better be bringing us intelligence.” We brought both…

Cadigan says the goal of the rationalization process is "to not create strategies in a vacuum rather provide relevant and timely solutions based on our partner firms allocation objectives whether  it’s non-traditional income sources, enhanced hedging strategies, momentum based options to complement growth and value as return factors."

"There exists an opportunity to take various asset classes that historically  required a tactical approach to the exposure like commodities, real estate, currencies and make them more of a strategic buy and hold position through long, flat or short methodologies. This is key given that most advisors do not have discretion  of client money," he says.

One of the advantages of this process, according to Cadigan, is that it marshals support for the product right from the beginning.

Again, in the case of the GYLD ETF, Cadidan says "when we launched the fund we went back to those who had asked for the strategy and asked them to help launch the fund vs. the typical industry model of seed, what for track record  and launch. The sales team actively listened to our constituents and through collaboration with our strategy development team and portfolio we came up with an industry first."

"We continue to see new ways to execute strategies that were unheard of 5-10 years ago," he says. 

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