Mega Trends in the Fund Industry Part 1 | Liquid Alternatives

What’s top of mind for mutual fund and ETF managers today? Many firms would say that liquid alternatives and Big Data are very high on their agendas.

In this 2 part NICSA News series, we will break down these two priorities covered at this year’s at NICSA workshop “Megatrends in the Fund Industry” which was held in Los Angeles on May 7th.

iStock_000023488582SmallLiquid alternatives. Admittedly, it’s hard to imagine a fund industry where regulation isn’t taking up all the bandwidth, as it has since 2008. But now that the outlines (if not all the details) of the post-credit crisis regulatory regime are in place, the industry can focus again on generating growth — and liquid alternatives funds have become a key driver of that growth.

The fact is, assets in liquid, or retail, alternative funds have been soaring. These funds use hedge-fund investment techniques, including leverage and short-selling, in a mutual fund format that can be sold to the general public.

The growth of liquid alternatives has been demand-driven, as investors — disenchanted with the volatility in the stock returns and low bond yields — search for greater diversification and protection on the downside. And the NICSA panel of experts, from Brown Brothers Harriman, EY and Franklin Templeton, believe that the demand will be sustained.

As a result, almost everyone in the investment industry — both hedge funds and traditional mutual fund and ETF managers — are exploring the market. But it’s not clear which type of firm has the edge in sponsoring this type of fund.

Hedge funds may have more experience with the investment techniques, but none at all with the extensive regulations that govern fund operations. Traditional fund managers may have the retail distribution networks needed to drive asset growth, but could find that the more aggressive liquid alternatives funds don’t mesh well with their brand image.

For both types of firms, liquid alternatives funds place heavy demands on investment operations and compliance. Extensive use of derivatives, short sales and leverage requires sophisticated approaches to collateral management, while holdings of less liquid securities, swaps or options pose valuation challenges. Compliance teams need new techniques for monitoring these complex strategies.

And it’s not just compliance teams that are keeping their eye on liquid alternatives; the SEC is also watching to the growth in this category. As keynote speaker Robert Robertson from Dechert noted, the SEC worries that liquid alternatives are an appealing “bright, shiny object” with a less-obvious sharp edge. Given the SEC attention to this area, asset managers should be sure to have their compliance programs in order.

Later this week, we will recap the big data conversation from the “Megatrends in the Fund Industry” event in Part 2 of this NICSA News blog series.

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