The year 2014 witnessed the average alternative mutual fund outperform the average single manager hedge fund by 58 basis points. Single manager hedge funds returned an average of 3.78 percent, while alternative mutual fund returned an average 4.36 percent during the same period. At the same time, the S&P 500 sported 11 percent gains. What’s an investor to do!
Alternative mutual funds tout five distinct advantages for would-be investors, liquidity, robust regulation, superior returns, reduced fees and limited barriers to participation. But are alternative mutual funds the “blue-light special” of investment strategies?
Both open and close-ended funds are extremely liquid compared to hedge funds. Those investing in open-ended funds can redeem on any trading day and receive the current market value in 5 days or less. Close-ended investors can redeem only at maturity but can sell units in the secondary market like stock. In short, alternative mutual funds’ claims of liquidity are valid.
Mutual funds, including alternative mutual funds are subject to a greater degree of regulation and oversight than are hedge funds. Mutual funds, unlike hedge funds, are required to register with the SEC. Additionally; the Investment Company Act of 1940 requires that mutual funds have a board of directors, 40 percent of whom must be independent, charged with the responsibility of looking after the shareholders interests.
The average performance of alternative mutual funds exceeded the average performance of single manager hedge funds in 2014 by 58 basis points. However, this is not indicative of a trend the relatively short track record of alternative mutual funds.
At first blush, fees for alternative mutual funds appear lower than hedge fund management fees. However, alternative mutual funds are notorious for a variety of other fees, including “loads” and expense fees. The totality of these fees can meet or exceed average hedge fund management fees. For example, mutual fund expense fees average 74 basis points, but the average expense fees for alternative mutual funds stand at 134 basis points.
Unlike hedge funds, limited to a clientele consisting of qualified investors, alternative mutual funds are open to anyone having the price of admission, which is typically $1000 to $5000. Hedge funds seek investors with $1 million or more to invest and these investors need to prove they can afford to lose it.
Pretenders to the Throne
Alternative mutual funds lack appeal for institutional and other major investors for the following reasons.
- Liquidity is not a major concern for institutional investors who have fractional amounts of their total assets under management invested in hedge funds.
- Institutional investors view highly regulated investment vehicles as impediments to successful strategies.
- Returns, while important, must be viewed through the lens of risk mitigation.
- Fees are always negotiable and institutional investors have enjoyed significant successes in securing fee reductions.
- Lastly, entry barriers are not a concern for institutional investors.
For these reasons, alternative mutual funds will remain pretenders to the throne occupied by hedge funds.