WA DFI: Investor Bulletin - Alternative Mutual Funds Are Not Typical Mutual Funds

An alert from The SEC’s Office of Investor Education and Advocacy

Alternative mutual funds (sometimes called alt funds or liquid alts) are publicly offered, SEC-registered mutual funds that hold non-traditional investments or use complex investment and trading strategies.  Investors considering alt funds should be aware of their unique characteristics and risks.

Investment Objectives:  Alternative mutual funds include a wide range of investment objectives designed to meet various investment needs.  Many alt funds try to minimize swings in the value of their investments and reduce risks by spreading their investments among different asset types and/or using complex trading strategies.  Some alt funds seek to generate above-market returns relative to other mutual funds that have a similar benchmark.
Investments:  Unlike traditional mutual funds, alt funds often seek to accomplish their investment objectives by investing in non-traditional investments.  For example, alt funds might invest in assets such as global real estate, start-up companies, or commodities such as gold or oil.  These investments can sometimes offer greater diversification or different returns than more traditional investments such as stocks, bonds, and cash.
Strategies:  Alt funds generally use more complex investment and trading strategies than more traditional mutual funds.  For example, alt funds may sell stocks short, use derivatives, or follow "absolute return" or “market neutral” strategies that seek positive returns even when the stock markets fall.  However, these strategies may result in higher costs and additional risks than traditionally managed funds.
How Do Alternative Mutual Funds Compare with Hedge Funds?

Alternative mutual funds often have similar investments and strategies to those of hedge funds, and thus alternative mutual funds may sometimes be marketed or sold as “hedge fund-like” options for retail investors.  However, alt funds differ from hedge funds in several important ways.

Regulatory safeguards:  As mutual funds, alt funds are regulated under the Investment Company Act of 1940, which provides certain safeguards.  These protections include limits on illiquid investments, restrictions on borrowings and debt, and the requirement to allow investors to sell their shares at any time.  Hedge funds are not required to follow these regulations, and therefore may pursue non-traditional strategies and investments without the same regulatory safeguards.
Open to the public:  Any investor may purchase shares of alternative mutual funds.  In contrast, hedge funds shares can only be purchased by “accredited investors” or “qualified purchasers” who are required to have a minimum level of income or assets.  This is designed to limit investors in hedge funds to those who are financially sophisticated and generally can bear the risks of investing in funds that are not subject to the regulatory safeguards.
Potentially Lower Fees:  Investors in alternative mutual funds generally pay lower fees than hedge fund investors.  Many alternative mutual funds have an annual fee equal to two percent or less of the fund’s assets.  In contrast, investors in hedge funds generally pay advisory fees at a similar level plus a percentage of any profits earned.  For example, one fee structure is the so-called 2/20 meaning an advisory fee which is generally equal to 2 percent of the fund’s assets, plus a 20 percent fee of any profits earned.
Read more: http://www.dfi.wa.gov/consumer/alerts/investor-bulletin-alternative-mutual-funds-are-not-typical-mutual-funds

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