Given market conditions in the last five years, the demand for retail alternatives is not difficult to understand. It appears that individual investors are moving to absolute-return investing and embracing alternative strategies for the same reasons institutional investors have: they need to tamp down volatility, hedge against major downturns and bridge the gap between actual and targeted returns.

According to aCerulli report, 90% of asset managers are looking to develop four or more alternative mutual funds over the next 12 months, perhaps because the retail market offers private fund managers the chance to diversify their revenue streams, earn more consistent fees and market their capabilities with fewer restrictions. While private fund managers can think of the retail market as another spoke to their distribution networks, the move into the retail space can be a big leap - one that requires a substantial commitment of time and resources.

In order to launch a successful registered fund, private fund managers must consider the following marketplace challenges:

* Distribution. With more than 300,000 registered advisors spread across a variety of U.S. sales channels, the distribution of retail alternatives can be a complex maze that also includes specialty consultants and intermediary platforms. Regardless of which channel managers elect to pursue, they will need to develop and implement marketing strategies, understand platform requirements and maintain specialized distribution or sales teams.

* Education. Alternative strategies are varied, complex and often abstruse, even to investment professionals. Even when they understand the broad concepts behind a strategy, they need a deeper understanding of its workings and how it fits into investor portfolios. Not surprisingly, nearly half of individual investors (48%) said they have little or no understanding of alternatives, and nearly two-thirds (64%) said they would need to learn more before investing, according to a recent Natixis survey.

* Track Record Requirements. In the realm of private funds, institutions may give promising start-ups a chance, even with little or no track record. Such is not the case in the retail world. Funds typically need to have a minimum performance track record before intermediary platform gatekeepers will consider them. Given the shortage of long-term performance track records for retail alternative products - Morningstar found that only 36% of U.S. retail alternative funds had a five-year record of performance data - managers looking to enter the retail alternative space should begin strategic planning efforts in a registered format well in advance of fund launch dates.

* Strategy Suitability. The first requisite for a retail offering is a viable investment strategy. The Investment Company Act of 1940 subjects mutual funds to greater limitations on investment strategies than private funds. Some strategies commonly employed by funds are therefore better suited to retail packaging than others. Long/short equity, market-neutral, merger arbitrage, global macro, currency, managed futures, and other multi-asset strategies are all potential candidates for open-end mutual fund packaging, as long as the use of illiquid assets and leverage remains within allowable limits. Managers should consider both liquidity restrictions and diversification requirements when deciding what strategies to offer and the vehicle through which to offer them.

* Product Packaging. Another fundamental question is which retail vehicle to use for packaging the strategy. Open-ended mutual funds are the most widely used option, however closed-end funds are also a viable vehicle. For private fund managers looking to ease into the registered '40 Act world, setting up a closed-end fund is an option worth entertaining, as assets can be raised through a one-time initial public offering rather than through ongoing marketing via a distributor. When making any product-packaging decision, though, managers should factor in the requirements and costs of both short- and long-term distribution.

* Fund Structure and Governance. Fund managers may sponsor their own mutual funds, which means being responsible for distribution and operations, or alternatively they may act as a sub-advisor for a fund. While direct sponsorship offers greater control over the product and its distribution, marketing and brand-building, many private funds choose to be sub-advisors, allowing them to focus on investment management while the sponsoring firm handles distribution, administration and back-office functions.

Fund managers who directly sponsor mutual funds must choose whether to offer stand-alone funds or structure them as part of a shared trust (also known as a series trust). While a stand-alone fund structure gives managers greater control over infrastructure decision-making, a shared trust can lower operation costs, provide access to trust-level selling agreements and shorten time to market.

The market for retail alternatives is immense, growing and still in its infancy. Private fund managers who want to capitalize on the potential of retail alternatives to diversify revenue streams and find new outlets will need to overcome a number of obstacles, devote substantial time and resources to educational efforts and find ways to fill their gaps in fund infrastructure and distribution expertise. While the challenges involved in stepping across this chasm are not to be underestimated, a number of leading private fund managers have not only made the leap into the retail market, but have also committed to expanding their retail footprints in the years to come.

Jonathan Dale is distribution director for SEI's investment manager services group.

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