The alert, “Alternative Funds Are Not Your Typical Mutual Funds,” discusses how alternative or “alt” mutual funds are publicly offered, 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.
“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 or she 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.