5 Things to Know About Liquid Alternative Mutual Funds

Arden Staff | February 3, 2014

What are alternative mutual funds?

Alternative mutual funds, also known as “liquid alternatives” or “alt funds,” are mutual funds that give investors access to portfolios that are professionally managed by hedge fund managers.

Unlike investors in hedge funds, however, individuals who want to invest in alternative mutual funds don’t have to have a net worth of more than $1 million or an income greater than $200,000. Historically, most hedge funds have also had high minimum investment requirements, making them inaccessible to the average investor. But in the last several years, both hedge fund managers as well as mutual fund companies have begun offering alternative funds to individual investors without income or net worth requirements and with minimums as low as $1,000.

Why would I want to invest in an alternative mutual fund?

With the U.S. stock market near all-time highs, it’s more important than ever to diversify and balance your portfolio. Unlike many traditional stock or bond funds, alternative funds can take defensive positions—such as short selling a stock in anticipation of a decrease in share price, to give one example—in efforts to protect and grow your capital regardless of market conditions, similar to the goal of hedge funds.

But aren’t hedge funds risky?

No investment is without risk. Many hedge fund strategies, however, involve the use of protective measures— or “hedges”—against risk, although these protective measures do not guarantee a fund will not lose capital. Furthermore, any single fund can lose money for a variety of reasons. To protect against this, some alternative funds use a “multi-manager” approach, which means that the fund’s adviser allocates the assets of the fund to a group of carefully selected hedge fund managers, or sub-advisers, that will employ different investment strategies. The fund adviser can pick the sub-advisers it believes to be the most capable of generating attractive returns and then continuously monitor the sub-adviser’s investment decisions to ensure it remains true to the fund’s stated mandate. This structure provides diversification typically not available through a single manager fund and may further reduce risk. When this strategy is implemented as a mutual fund, it is known as a multi-manager liquid alternative mutual fund, although it is important to note that not all alternative funds are multi-manager.

So what are some differences between an alternative mutual fund and a hedge fund?

Alternative mutual funds are just like those mutual funds that you may invest in through your retirement or college savings accounts, but the investment strategies used more closely resemble those of hedge funds. Like other mutual funds, alternative mutual funds are registered with and regulated by the SEC under the Investment Company Act of 1940. They are open-ended and more liquid than hedge funds because shares can be purchased and redeemed daily (hence their moniker “liquid alternatives”), and their fee structure is like a traditional mutual fund. Hedge funds typically have strict redemption limits that hinder withdrawing assets from the fund.

What makes them “alternative”?

There are several ways to define “alternative funds,” but one way is by comparing them to traditional mutual funds that buy and sell stocks and bonds in the hopes that their value in those investments increase. By contrast, alternative mutual funds may hold non-traditional investments such as options, futures, derivatives and commodities and employ more complex trading strategies which potentially may cause the fund’s performance to have a lower correlation overall to the equity and debt markets. Finally, while many traditional mutual funds generally remain fully invested whether markets are rising or falling (and may move only a portion of the fund out of their core strategies when needed for defensive reasons), alternative funds more frequently include non-traditional allocations that involve tactically increasing and decreasing risk as part of their value proposition.