Alternative mutual funds are 1940 Act products that utilize hedge-like strategies while offering daily redemptions and increased transparency alongside the fee structure of a traditional mutual fund. These funds have seen a surge in activity over recent years; Preqin’s June issue of Hedge Fund Spotlight revealed that the number of annual fund launches has increased dramatically, from 13 in 2009 to 71 in 2014.
This jump in launches has brought about increased scrutiny from industry stakeholders, as the SEC seeks to examine this growing structure to ensure retail investors are sufficiently aware of associated risks and are adequately protected. Preqin’s Hedge Fund Analyst tracks 426 alternative mutual funds with aggregate assets under management of $264bn.
Preqin’s Liquid Alternatives: Investor and Fund Manager Outlook report shows that from 2009 onwards, launch numbers have risen significantly. There were an average of 14 funds launched each year between 2005 and 2009, compared with 50 between 2010 and 2014. The number of funds of hedge funds launched focusing on alternative mutual funds has also increased; in 2014, 40% sought to focus on alternative mutual funds, compared with 13% in 2013 and in 2012, only 6%.
While launch numbers have been strong for alternative mutual funds, their performance over recent years has not been on a par with the Preqin All-Strategies Hedge Fund benchmark, though the gap in performance may be bridged by the lower fees and more favourable terms offered. Alternative mutual funds have a five-year annualized return of 6.73% compared to 8.46% for all hedge funds, and they have returned just 2.83% over the last 12 months compared with 7.30% for all hedge funds. In 2015, the picture is fairly similar, with alternative mutual funds returning 2.40% as of May, compared with 5.44% for the overall benchmark.
Daily redemptions require these funds to hold a large proportion of their portfolio in liquid assets or cash. There are also leverage limits imposed, as well as restrictions on instruments that can be traded, all of these factors can dampen returns. Conversely, according to the 2015 Preqin Global Hedge Fund Report, 75% of single-manager hedge funds offer monthly or longer lock-ups, affording them more time to realize outsized returns and ride out market volatility without capital being withdrawn by some investors and consequently damaging returns for the remainder – another cause of concern cited by regulators.
In August 2014, the SEC announced a broad examination of alternative mutual funds, arguing that these funds fall into a grey area of mutual fund regulation and their behaviour in regards to leverage and liquidity-required inspection. One year later, the results of the investigation are yet to be published, but it will be interesting to see whether the SEC believes these funds need to be subjected to greater scrutiny and regulatory requirements and how this will affect the growth of assets and volume of fund launches within this sub-sector of hedge funds.