17 July 2019

SEC Launches “Sweep” of Alternative Funds

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The Securities and Exchange Commission has launched a broad examination of alternative mutual funds, kicking off regulatory scrutiny of one of the hottest and most controversial investment products to be offered to small investors. The so-called funds "sweep" includes examinations of large investment firms such as BlackRock Inc. and AQR Capital Management LLC but also smaller firms that previously didn't offer mutual funds.

The agency's goal appears to be to gather information about the industry, not necessarily to deliver enforcement actions. Still, advisers to fund companies fear the examination could put a chill on the industry's aggressive growth plans for these popular new products.

Alternative funds, or "liquid alternative funds," describe a class of mutual funds that employ hedge-fund-like strategies, including betting on some stocks and against others, trading futures contracts and using derivatives to increase leverage. Fund companies have marketed them as a way to hedge against market risk and as a cheaper way for individual investors to gain access to strategies once available only to sophisticated investors. Skeptics say some of the funds are watered-down versions of hedge funds and that some individual investors may not understand what they are getting.

Alternative funds have surged in popularity. The category saw inflows of $40.2 billion in 2013, up from $14.5 billion the previous year, according to fund research firm Morningstar Inc. According to the SEC, the amount of money in the funds jumped by 63% last year, from $158 billion to $258 billion.

The SEC is focusing on the liquidity of the funds, their use of leverage and the degree of oversight provided by the funds' boards. The regulator is questioning not just the funds' managers, but, in some cases, has also sent letters asking to speak with mutual fund board members.

The regulator had previously signaled it would likely start its sweep of such funds this summer or fall. It's not clear how many funds have been contacted.

In a statement, Jane Jarcho, head of the SEC's investment company and adviser exams, said the agency plans to complete exams of about 30 firms offering such funds by April. Depending on the results, the SEC will decide whether or not to examine more fund companies.

A bevy of prominent hedge-fund firms has signed on to start or help advise the funds, encouraged by the prospect of attracting what they view as a relatively stable base of money. The funds can help firms grow: When AQR Capital Management LLC, a pioneer in the space, launched its first such mutual fund in 2009, it managed $20 billion. It managed $113 billion at the end of June, including roughly $15 billion in both traditional and alternative mutual funds.

But not all fund companies are on board. Vanguard Group Inc., the country's largest mutual fund firm, told The Wall Street Journal in May that it was avoiding expanding into the space. Some financial advisers also say they won't offer them because of their complicated strategies that are confusing to small investors, and lack of long-term track records.

Click here to access the full article on The Wall Street Journal.

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