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Rise of Alternative Mutual Funds in the Alternative Universe – September 2015

by Arun Chopra

  • 07 Sep 2015
  • HF

Alternative mutual funds have become more prominent in the alternative universe over the past several years, with annual numbers of fund launches growing rapidly. These funds emulate hedge fund strategies but offer the transparency and liquidity of the familiar mutual funds structure, factors which have proved attractive to the many different types of investors that have added alternative mutual funds to their investment portfolios.

Investors have good reasons to be attracted to such funds; they offer lower fees, transparency and daily redemptions that often cannot be found in most alternative funds. However, alternative mutual funds are also subject to leverage restrictions and limits upon the instruments that can be traded, which may dampen returns. Eight percent of the fund of hedge funds managers tracked by Preqin’s Hedge Fund Investor Profiles include alternative mutual funds within their structural preferences. Managers are likely launching products with an alternative mutual fund focus to tap into the growing and broad base of investors attracted to such funds, which extends to smaller and retail investors, as well as the attractive return profile relative to the costs. Some managers are also acting as intermediaries to direct capital towards the alternative mutual fund sector.

Excluding funds of hedge funds, foundations are the largest investor by number, making up 45% of alternative mutual fund investors. Pension funds also make up a notable proportion of mutual fund investors (excluding funds of hedge funds) at 25%, likely due to their medium investment time horizon and tendency to be more fee sensitive, looking at products with lower costs. Endowments make up only 6% of institutional investors (excluding funds of hedge funds) in the alternative mutual fund space, likely due to their long investment horizon and relatively lesser need for liquidity.

Preqin’s Hedge Fund Analyst also shows the number of annual alternative mutual fund launches has increased each year since 2009, from 13 in 2009 to 71 in 2014. Alternative mutual funds posted three negative months of performance in the first five months of 2015, in contrast to single manager hedge funds’ five positive months. However, alternative mutual funds posted a loss of -1.28% in June, but a small positive return of 0.07% in July, compared with single manager funds’ -0.9% for June and -0.34% for July. The year to date figure in July 2015 stands at 1.53% for alternative mutual funds, less than half the 4% posted by the single manager funds benchmark.

Whilst returns of alternative mutual funds may initially look less attractive than those of hedge funds, the underperformance may be offset by the increased liquidity and transparency and lower fees, which may make alternative mutual funds a viable and often more accessible alternative to hedge funds for many investors. With investors continuing to cite fees as a main concern in hedge fund investing, it is likely that the number of investors and launches of such funds will continue to grow.

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