The Markets June 11, 2013

FINRA Encourages Awareness of Alt Fund Differences

The Financial Industry Regulatory Authority (FINRA) issued an alert advising investors to be aware of the unique characteristics and risks of alternative funds.
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The alert, “Alternative Funds Are Not Your Typical Mutual Funds,” discusses how alternative or “alt” mutual funds are publicly offered, Securities and Exchange Commission (SEC)-registered funds that hold more non-traditional investments and employ more complex trading strategies than traditional mutual funds.

Alternative funds might invest in assets such as global real estate, commodities, leveraged loans, start-up companies and unlisted securities that offer exposure beyond traditional stocks, bonds and cash, said FINRA. These funds also may employ complex strategies, including hedging and leveraging through derivatives and short selling. Some alternative funds are structured as a fund containing numerous alternative funds. Although the strategies and investments of alternative funds may bring to mind those of hedge funds, alternative funds are regulated under the Investment Company Act of 1940, which limits their operations in ways that do not apply to unregistered hedge funds.

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“Investors should fully understand the strategies and risks of any alternative mutual fund they are considering,” said Gerri Walsh, FINRA’s senior vice president for Investor Education. “FINRA is warning investors to carefully consider not only how an alt fund works, but how it might fit into their overall portfolio before investing.”

FINRA’s alert asks investors considering these funds to ensure that they fully understand the alternative fund’s:

  • Investment Structure: An alternative fund-of-funds may offer greater diversification than a single-strategy or even multi-strategy alternative fund. At the same time, this greater diversification may lead to a flattening of return and potentially less transparency.
  • Strategy Risk Factors: In addition to the usual market- and investment-specific risks mutual funds have, alternative funds carry risks from the strategies they use.
  • Investment Objectives: One fund might be designed to capitalize on management expertise in a specific area (e.g., investing in distressed companies), while another might seek exposure to commodities, currencies and other alternative investments.
  • Operating Expenses: Alternative mutual funds can be pricey relative to their traditional managed fund peers. The average annual operating expense is around 1.5% per year.
  • Fund Manager: Learn as much as you can about the fund manager, such as how long he has managed the fund. Research the professional background of a fund manager using the FINRA BrokerCheck online tool.
  • Performance History: Many alternative funds have limited performance histories. For example, a fair number were launched after 2008, so it is not known how they might perform in a down market.

The full text of the Investor Alert can be viewed here. The FINRA BrokerCheck tool can be found here.

The Markets June 11, 2013

PSNC 2013: Thinking Outside the Box

A standard mutual fund lineup may not be enough for your plan.
 
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Defined contribution (DC) plans have always underperformed defined benefit (DB) plans, Scott Brooks, director and head of U.S. Defined Contribution at Deutsche Asset & Wealth Management, told attendees of a panel discussion at the PLANSPONSOR National Conference. Use of alternatives is unusual in DC plans, he said, but more common in DB plans. These funds’ performance (or failure) may be linked to their willingness (or reluctance) to employ alternatives. Brooks distinguished between alternative assets and alternative strategies, which use traditional assets to retrieve alternative returns. The use of either, he said, offers increased return potential for a plan.  

Doug Prince, CEO of ProCourse Fiduciary Advisors LLC, advised plan sponsors to consider the overall risk tolerance of their participants. What are the plan sponsor’s goals and objectives? Does the plan sponsor want people to stay in the plan—even after they leave the company? Active or passive?  

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For target-date funds (TDFs), at least, Prince said: “There is no passive target-date fund.” He anticipates dramatic changes will be made to target-date funds in the next five to 10 years. There could be TDFs that consider more than just the target date of retirement. If a lifecycle/lifestyle hybrid fund was developed, plan sponsors could enroll their participants into a conservative, moderate or aggressive fund for their target retirement year.  

Prince explained the 90/9/10 rule to attendees: 

  • 90% of participants likely want the plan sponsor to “do it for them”; 
  • 9% of participants will want some leeway with their investments, but “in a padded room”; 
  • 1% of participants will want to do it themselves. 

With this in mind, Kevin Petrovcik, managing director and senior client portfolio manager at Invesco, said it should be every plan sponsor’s goal to find the best optimal return with minimal risk. He asked attendees: Wouldn’t you rather have an adviser directing asset allocation than individual participants?
 

 Sara Kelly 

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