08.29.2013
By Terry Flanagan

Fund of Fund Advisors Launch Retail Investment Vehicles

Hedge fund of fund advisors are beginning to play a key role in the launch of new alternative investment retail products.

Fund of fund advisors such as Arden Asset Management, Blackstone and Morgan Stanley Alternative Investment Partners are launching multi-manager, multi-strategy mutual funds that take advantage of their deep expertise in the hedge fund space.

“These firms are leveraging their relationships with talented hedge fund managers and convincing them to participate in the retail channel via mutual fund structures where the fees are not nearly as lucrative as they are in private partnerships,” said Brian Haskin, CEO of Alternative Strategy Partners.

Brian Haskin, Alternative Strategy Partners

Brian Haskin, Alternative Strategy Partners

The retail channel provides a new source of assets for the hedge fund managers, and one that is just beginning to grow.
Individual hedge fund managers, along with retail asset management firms, have been the leading providers of single strategy mutual funds in the retail channel. This will likely continue to be the case even as the market for alternative products evolves.

“Hedge fund managers are leveraging their investment expertise and launching single strategy products in the retail channel either on their own, as Whitebox Advisors and 361 Capital have done, or in partnership with a retail-oriented asset management firm, as Cedar Ridge Partners has done with Forward with the Forward Credit Analysis Long/Short Fund,” said Haskin.

“For liquid assets and strategies, the structural pros and cons of different investment structures for alternative assets (e.g., mutual and closed-end funds, SMAs, ETFs, etc.) are similar to existing financial products,” said Brad McMillan, vice president and chief investment officer at Commonwealth Financial Network, an independent broker-dealer with 1,600 investment advisors and $72 billion in assets under management.

However, for illiquid assets and strategies, the potential mismatch of assets and liabilities poses significant problems for open-ended structures.

“At Commonwealth, we do not do proprietary products, a stance I largely agree with,” McMillan said. “While conflicts can certainly be managed between product and asset management, there is an advantage to avoiding them altogether.”

Liquidity and pricing are the main challenges associated with delivering alternative assets in a ’40 Act wrapper.
“For strategies that use liquid, regularly priced underlying assets, there are few new risks,” McMillan said. “For any product that does not do so, a public product imposes significant reporting requirements that will be difficult to comply with.”

Both fund of fund advisors as well as hedge fund managers will be important players as the demand for liquid alternative strategies continues to grow.

Fund of fund advisors and hedge fund managers will bring their expertise to the market in different ways, each serving different segments of the retail channel.

For those investors or intermediaries looking for a one-stop solution, the multi-manager, multi-strategy products from the large, fund of fund advisors will fill the need,” said Haskin. “Other investors, with deeper expertise in manager selection and portfolio construction will use the more focused single manager strategies to fill very specific mandates within an overall portfolio context.”

To date, mutual funds have served as the most common structure for liquid alternative products. This is primarily driven by the fact that most alternative strategies are actively managed, and mutual funds provide managers with the greatest level of flexibility for implementing their strategies.

Many of the strategies involve the use of shorting and leverage, along with the use of derivative instruments such as futures and forward contracts, swaps and options.

“Mutual funds allow for the use of all of these, thus giving the managers the ability to fully implement their investment approaches,” Haskin said. “In addition, mutual funds only require quarterly disclosure of holdings, thus providing mutual fund managers a reasonable level of anonymity when implementing new ideas. At the same time, investors have full access to portfolio holdings at least four times per year.”

The introduction of active ETFs allows money managers to manage an ETF without systematically following a published benchmark or index, such as the S&P 500 Index.

“This development, along with the fact that some managers are comfortable with the required daily disclosure of portfolio positions, has resulted in the introduction of a wide range of alternative ETF products such as the IQ Merger Arbitrage ETF, the AlphaClone Alternative Alpha ETF and the AdvisorShares Accuvest Global Long Short ETF,” Haskin said. “Each of the managers for these products takes a systematic approach to investing, thus mitigating the need for confidentiality around the underlying portfolio holdings.”

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