Alternative Funds Are Not Your Typical Mutual Funds
Alternative or "alt" mutual funds are publicly offered, SEC-registered funds that use investment strategies that differ from the buy-and-hold strategy typical in the mutual fund industry. Compared to a traditional mutual fund, an alternative fund typically holds more non-traditional investments and employs more complex trading strategies. Investors considering alternative mutual funds should be aware of their unique characteristics and risks.
What Are Alternative Funds?
As their name implies, alternative mutual funds seek to accomplish the fund's objectives through non-traditional investments and trading strategies. Alt 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.
The strategies alternative mutual funds employ tend to fall on the complex end of the spectrum. Examples include hedging and leveraging through derivatives, short selling and "opportunistic" strategies that change with market conditions as various opportunities present themselves. Some alt funds employ a single strategy (single-strategy funds). For instance, they may offer 100 percent exposure to currencies or distressed bonds, or employ a market-neutral or "absolute return" strategy that uses long and short positions in stocks to generate returns. Others may employ multiple strategies (multi-strategy funds) such as a combination of market-neutral strategies and various arbitrage strategies. Still others are structured as a fund containing numerous alternative funds, a special type of "fund of hedge funds."
In some cases, the fund's primary objective is to generate above-market returns. In other cases, a fund's main goal is to help investors better manage risk with strategies designed to smooth out volatility or offer greater diversification.
How Do Alt Funds Compare with Hedge Funds?
Although the strategies and investments of alt funds may bring to mind those of hedge funds, the two should not be confused. Alternative mutual funds are regulated under the Investment Company Act of 1940, which limits their operations in ways that do not apply to unregistered hedge funds. These protections include:
Furthermore, investment advisers to mutual funds, including alternative funds, are not allowed to charge investors a "2/20" performance fee for advising the fund, as their private hedge fund adviser peers can. Hedge fund advisers often charge a fee equal to 2 percent of the fund's assets, plus 20 percent of gains that the fund produces during a given period.
Before You Invest
Like any investment, alternative mutual funds have their pros and cons. Before you invest in an alternative fund, here are some points to keep in mind:
So do your homework and comparison shop. There may be other investment options to alt mutual funds that that are less complicated and cost less, but still help you accomplish your financial objectives.
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