Alternative Mutual Funds
Alternative mutual funds are simply non-traditional mutual funds. Instead of investing in typically stocks and bonds, alternative mutual funds are funds that basically invest in hedge funds. These underlying hedge funds may employ unique trading or investment strategies or may invest in everything from traditional stocks and bonds to complex commodity futures and options, global real estate, leveraged loans, start-up companies or even unlisted securities. An alternative mutual fund will invest generally in a portfolio of these hedge funds, much like a regular or traditional mutual fund would invest in a portfolio of stocks, bonds, options, etc.
Alternative mutual funds are registered with the Securities & Exchange Commission, and are offered publicly to investors. These funds may be sold as closed end funds. Unlike private hedge funds, alternative mutual funds are regulated under the Investment Company Act of 1940.
Alternative mutual fund strategies are generally complex and may include hedging and leveraging through derivatives, arbitrage, short selling or other strategies. Some funds have a single strategy, others may have multiple strategies, and invest in a fund containing numerous other alternative funds, or “fund of funds.” Each fund, given its particular investment objective, will generally have different diversification requirements, investment limitations, limitations on the use of leverage, limitations on the investment in illiquid securities, over concentration, market pricing and redeemability.
Alternative Mutual Funds Yield a Higher Risk
Alternative mutual funds are significantly riskier than conventional mutual funds. Like all other mutual funds, alternative mutual funds also have a Net Asset Value or NAV. However, unlike traditional mutual funds, because the assets of an alternative mutual fund consists of its interest in the underlying hedge fund assets, which may own non-marketable, illiquid or otherwise non-traditional securities, the actual value of these funds may not be exceedingly transparent. Moreover, in a variety of circumstances, these interests in the underlying hedge funds, may not be readily redeemable.
Stockbrokers and broker-dealers offer these securities to retail customers as a way to invest in hedge funds, or hedge fund like strategies. Within the last seven years the combined “assets under management” of alternative mutual funds has increased from $50 billion in 2008 to approximately $300 billion as of December 2014. There are now more than 200 securities broker dealers that offer these funds to retail customers.
Complexity Causes Concern
Because these funds are exceedingly complex, the Financial Industry Regulatory Authority or FINRA is concerned that registered representatives or stockbrokers often may not understand how the funds will respond to various market conditions or what strategies a fund’s advisor may effect in changing or varying market conditions. Although all broker dealers are required to conduct some from of due diligence with respect to the sale of these funds, FINRA has found that many of these offerings lack meaningful due diligence when offered by already established or approved mutual fund sponsors. FINRA also lists alternative mutual funds as one of its 2015 “Regulatory and Examination Priorities.”
In February 2017, The SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin concerning the potential risks associated with alternative mutual funds. SEC Issues Investor Bulletin Warning Investors About Alternative Mutual Funds.
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