Keeping Alternative Mutual Funds an Alternative

What exactly makes an alternative mutual fund “alternative”? 

According to Cindy Erickson Zarker, director at research firm Cerulli Associates, the definition of what constitutes an alternative investment fund has changed markedly since 2008. 

At that time, 100 percent of fund managers considered absolute return funds to be alternatives to traditional mutual funds. Such funds judge themselves by their ability to absolutely produce returns, in good or bad markets. They try not to settle for relative performance – returns better than other funds.

But only 87% of fund managers in 2012 hold the view that this defines an alternative fund today. Similarly, 67% of managers deemed currency funds worthy of the alternative classification in 2008 compared to 60% today.

Which means funds that start out as alternatives can change into mainstream.

“There is no black and white definition of alternatives,” said Zarker, in front of an audience of mostly service providers at the ICI Mutual Funds and Investment Manager Conference.

Now the types of mutual funds that can be classified as alternatives to traditional buy-and-hold equity and bond funds include: absolute return, commodities global tactical asset allocation, frontier markets (equity and debt), arbitrage strategies (e.g., convertible currency, merger/risk) and global infrastructure.

For example, Zarker said some global tactical asset allocation funds add a heavy dose of commodities exposure to make them more “alternative” than their peers.

Consolidation among broker-dealers and consultants have made marketing these products even harder for fund sponsors, according to Zarker. “There are different levels of education in terms of the overall asset class and product-specific offerings to external sales teams, gatekeepers and broker-dealers,” she said.

Ruth Epstein, a partner at law firm Stradley Ronon Stevens & Young, said the current state of the alternative mutual fund industry makes educating investors a lot less like Mutual Fund 101 and more like a graduate seminar.

“Alternatives mean many things to many people but investors are looking for something different with diversification. But can they work in a regulated concept?” she asks.

Issues such as limits on leverage, the level of liquidity and how to value assets are making the education process a necessity for fund sponsors, she said.

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