The heat is on this summer. And for the fastest-growing segment of the mutual fund industry, the temperature will continue to rise as the SEC begins its first phase of “sweep” exams.
The target under the Securities and Exchange Commission's 2014 exam priorities is alternative investments — including the mutual fund variety: liquid alts.
As
InvestmentNews reporter Trevor Hunnicutt
has reported, the popularity of retail funds using alternative strategies has ballooned. In 2013, flows into such funds reached $40.7 billion, up from $14.6 billion in 2012. These funds now hold about $154 billion.
The rush into liquid alts — largely attributed to investors' desperate reach for return in a low-rate environment while also trying to limit downside correlation with stocks — has caught the eye of regulators. And well it should.
The commission plans to evaluate three areas of alternative investments, including the fundamentals of leverage, liquidity and valuation, and the makeup of boards and staffs. The third area — the way these funds are marketed to consumers and the suitability of recommendations — is something advisers should take to heart.
DUE DILIGENCE
Performing perfect due diligence on funds with minimal track records is not easy. But understanding the investment strategy employed in the fund — long/short, managed futures, global macro, etc. — and checking the fund and fund manager's tenure is a start.
And when the adviser is confident that the fund meets a client's needs, that client must be educated on why the fund should be added to his or her portfolio. If an alternative investment's strategy is stability and non-correlation, for example, a client shouldn't be running to the adviser in a huff when the fund isn't matching the market's bull run.
The SEC plans to focus on 25 fund families in its proactive sweep, beginning the exams this summer and likely spanning about six months. By that time, the cool weather will be back and whatever comes to light from the examinations will be instructive for this growing pool of alternative funds and the advisers who tap them for clients.
