Hedge funds have endured the slings and arrows of multiple critics, including presidential contenders on both sides of the aisle, yet they remain the investment platform of choice for institutional investors and high net worth individuals.
This fact is not lost on the small investor who, unable to meet the definition of a qualified investor, still hungers for access to the hedge fund strategies so popular with the very wealthy. This is borne out by the tremendous interest engendered by liquid alternatives, also referred to as alternative mutual funds.
Liquid Alts Posed No Threat
Alternative mutual funds, although initially popular with small investors, failed to pique the interest of institutional investors and high net worth investors. Small investors poured billions into these new investment vehicles. However, these billions did not flow from hedge funds into liquid alts—conventional mutual funds were the losers … not hedge funds, largely because the majority of those investing in mutual funds and liquid alts would not meet the definition of a qualified investor and were never in a hedge fund.
Interval Alts May Prove a Greater Threat
Interval alternatives have much in common with their liquid alternative cousins. Like alternative mutual funds, interval alternative funds are SEC registered, have boards with forty percent of their directors defined as independent and, although they provide greater liquidity than hedge funds, are less liquid than liquid alternative funds.
By sacrificing liquidity, interval funds are empowered to employ investment strategies that more closely parallel hedge fund strategies. Interval alternative funds permit contributions or withdrawals in monthly, quarterly or other pre-defined intervals, unlike liquid alts which basically trade like stock.
Like hedge funds, interval alternative funds can assess a management fee and a performance fee. However, by choosing to charge a performance fee, the fund must sacrifice its ability to sell to anyone not meeting the definition of a qualified investor.
Interval alternatives offer an uncomplicated broker sales process, unencumbered by the complex hedge fund subscription process. Interval alts can provide 1099s for clients rather than the comparatively complex K-1 reporting of hedge funds. Interval alts, unlike hedge funds, can absorb an infinite number of ERISA and/or IRA investors without any need to alter their investment strategy, interpose a master/feeder or exotic offshore fund structure.
While it is unlikely that interval alternatives will entice institutional and high net worth investors from the hedge fund niche, interval alternatives may be the ideal investment vehicle for hedge fund managers to offer retail investors, opening the door to trillions in retail inflows.
Hedge fund managers with an interest in capturing some segment of the lucrative retail market would be well-served by considering the interval alternative fund. Interval funds have the potential to be less disruptive than liquid alternative funds. Of course, care must be taken to avoid conflicts with the existing assemblage of funds and the possible cannibalization of other products within the hedge fund.
While interval alternatives are unlikely candidates to unseat hedge funds, they may prove to be the best investment vehicle for hedge funds to employ in their quest for the retail investor.