Basic HTML Version
6
|
Introduction and Overview of 40 Act Liquid Alternative Funds
The alternative ’40 Act products with the largest
potential audience and themost uniform structure are
the open-end funds. These products are commonly
referred to as mutual funds in the United States, and
they span both single manager and multi-manager, or
multi-alternative, products.
All mutual funds must be brought to market by a
sponsor that has the ability to create the proper
structure for the mutual fund, file the regulatory
documents, apply to the exchanges for a ticker
symbol and set that symbol up for public access.
There are a limited number of providers eligible to
act as a sponsor for mutual fund products; those
thinking about launching a product must access one
of these providers.
Once the fund is officially launched, mutual funds
are priced daily and accept orders for subscriptions
and redemptions. They are incorporated either as
corporations or unit trusts and can have unlimited
investors in a variety of standard share classes,
ranging from institutional to retail. As pooled
investment vehicles there is no limit on their overall
capacity, although there may often be minimum
investment sizes that investorsmust meet to purchase
fund shares. Mutual funds must provide daily liquidity
to investors and subscribe to a set of trading rules
that govern how they invest their capital. Under these
trading rules they must:
Maintain 85% of their portfolio in liquid assets
and hold no more than 15% of their assets in
illiquid securities (defined as instruments that
take longer than seven days to liquidate in the
public markets);
Cover the full value of liabilities created by any use
of short sales by holding an equivalent amount
of collateral within a separate brokerage or
custodial account;
Limit any use of leverage in their portfolio to 33%
of the gross asset value of the fund, using either
derivatives or securities as margin collateral.
Mutual funds are prohibited from charging
performance fees. The investment sub-adviser and
investment manager of alternative mutual funds
typically charge a combined management fee of
between 100 and 200 basis points of the fund’s AUM
for the institutional or investor share class, and then
offer additional share classes with additional fees
that are outlined in more depth in the marketing and
distribution section of this primer.
All mutual funds in the United States issue a 1099
form at the end of each year to investors that
categorizes the tax treatment of the fund’s income
and distributions. This differs from the privately
traded hedge fund industry, in which investors are
issued a K-1 form. Many individual investors view
1099s as superior because they must be issued by
January 31 of the following calendar year, whereas
K-1s have no mandated filing date. As such, most
investors in mutual funds are able to file their taxes
early in the year and benefit from any anticipated
tax refunds.
There are three different types of mutual fund
structures that are classified as ‘liquid alternatives’:
single-manager funds, multi-alternatives, and
commodities (or managed futures) funds.
Single Manager Mutual Funds
A mutual fund has both an investment manager
(IM) and an investment adviser (IA) associated with
the offering. There are two execution models for
single-strategy mutual funds. The first model is one
where the IM and the IA are the same company.
This approach most closely resembles a typical
hedge fund structure. The second model is one
in which the hedge fund manager is a single sub-
adviser (IA) to a mutual fund owned by a different
investment manager.
The mutual fund is set up either as a corporation or
a unit trust (we will discuss the pros and cons of each
legal structure in the next section). An independent
board of directors and set of service providers are
assigned to provide custody, fund administration,
transfer agency services, investor services and prime
brokerage services. The fund has a single IA who
has trading authority on the portfolio while staying
in compliance with all of the trading rules previously
discussed. The IM and the board are responsible for
overseeing the IA, as well as the calculation of the
daily NAV by the fund administrator.
Section II: Overview of Alternative Open-End Mutual Funds