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Introduction and Overview of 40 Act Liquid Alternative Funds
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fees that are assessed annually in addition to the
management fee. All in, Class A shares can be in the
range of 5.0% to 7.0% or more. If an investor puts
in a sufficient amount of capital, it may be able to
qualify for a breakpoint in its Class A fund purchase
that allows them to qualify for a discount on the sales
load. Class A shares are often seen as preferable
for investors that have both a significant amount of
investment capital and a long time horizon.
Class B shares usually have a deferred sales load,
payable when an investor redeems their fund. The
deferred sales load diminishes over time if the
investor holds the fund for several years and can
eventually convert to zero fee. When Class B shares
reach this point they often convert to a Class A
share, which is beneficial to the mutual fund owner
because the annual marketing charges on Class B
shares are higher than on Class A shares. There are
no breakpoints on Class B shares regardless of the
amount of capital the investor puts into their initial
purchase, and the expense ratio on these shares is
the highest of all the retail classes until the deferred
sales load expires. Class B shares are seen as
preferred vehicles if the investor has only a minimal
amount of capital but plans on holding its purchases
for an extended period; however, because of the high
expense ratio, this is often not as popular a share
class as the Class A and Class C shares.
Distribution Channels
There are multiple distribution channels that can
be leveraged to access investors for publically
traded alternative ’40 Act funds. As shown in
Chart 9, however, the choices available to the fund’s
investment manager are very much linked to the
amount of capital in the fund.
Most new alternative mutual fund products launch
with at least $20 million in capital provided by
the sponsoring IM, and they begin by offering an
institutional, or I, share class. Until a new fund
surpasses $50 million in capital, distribution options
are limited; it must consider either direct institutional
sales or finding sponsorship within the RIA networks.
RIAs are individual wealth managers, each of which
has discretion over its own client’s pool of capital.
Some RIAs are highly entrepreneurial and like to be
in on new public fund launches as seed or as early
stage investors, much like we see from many family
offices in the hedge fund space. Accessing these
RIAs typically requires a marketing relationship with
a specialty firm. Outside this specialized group of
early-stage investors, most RIAs operate as more
traditional buyers. They will consider smaller funds
for their clients, but often must be sold individually
on the merits of the fund. Since there are literally
thousands of such RIAs, this can be a daunting task
without the right distribution relationships.
In 2011, Cerrulli Associates estimated that total
assets controlled by RIAs, independent broker-
dealers that operate like RIAs and dually registered
representatives across the two types of entities
totaled approximately $4.0 trillion. This is reported
assets only, and the figure does not exclude potential
double-counting with other channels. This potential
asset pool and distribution approach is illustrated in
Chart 9.
As a fund’s AUM move up toward the $50 to $150
million zone, its distribution options expand. It is at
this juncture that many alternative mutual funds add
a C share class and begin to approach the wirehouses
to be included on their sales platform. There are 4
main wirehouses in the U.S.—Morgan Stanley’s Smith
Barney network, Bank of America’s Merrill Lynch
network, Wells Fargo and UBS Wealth Management.
The term wirehouse originated from the telegraph
wires that were used to connect the many national
branches of these firms to their headquarters and
the exchanges.
While more modern technologies have replaced
the telegraph wires—which were considered an
innovation at the time—the national reach of these
wirehouses and large network of financial advisers
at each of these firms still offer a powerful draw
and an attractive source for accelerating capital-
raising activities.
There is also an increase in the number of distribution
platforms that mimic the national distribution
networks of the original wirehouses. Bank broker-
dealers and insurance company broker-dealers
are additional outlets that each have their own
distribution platforms and affiliated sales forces
that can be used to promote alternative mutual fund
products. Regional broker-dealers can also be an
attractive option at this point in a fund’s development,
as they will often have extensive distribution teams
within specific geographic locations.
Together, Cerrulli Associates estimated that these
providers represented a total asset pool of $7.6
trillion, nearly double the size of the RIA, IBD and
dually registered marketplace.
Finally, as an alternative mutual fund nears $250 to
$500 million AUM, they can add their A and B share
classes and begin pursuing the distribution platforms
that are accessed directly by retail investors. Such
distribution channels include the online brokerage