Liquid Alts

Does anyone here work with liquid alts? Alternative investment mutual funds are growing like crazy and I’d love to hear the opinion of someone who works with/sells these products regularly.

For those that don’t know, liquid alts are just alternative investment strategies that are sold in a mutual fund. They are restricted on leverage, can’t hold illiquid investments and can’t pay their managers an incentive fee. So outside of a long/short equity or managed futures strategy, these things barely represent the actual strategy they’re promoting.

I work extensively with liquid alts. Once you get past the differences in the vehicle structure (fees, taxation, leverage, shorting max, etc.), you can get to the business of understanding which strategies may be replicated well in a mutual fund, and those that can’t be.

It is also helpful if you can obtain comparable track records of the 3©1 prior to the mutual fund’s launch, if the track record is too short, and if the private fund details are largely similar to the mutual fund version.

Lastly, understand that equity hedge and macro strategies will have much higher capacity limits before they close than event driven or relative value. ED or RV sweet spots might be in the $200 million to $300 million range for AUM, which is low for someone used to dealing with long only mutual funds.

As with any selection, tight due dili is key.

DoW, thank you for that feedback. Unfortunatly I believe it is the vehicle structure that sets these funds up for failure.

Can you tell me what the rational is among the industry as it pertains to the fee structure? imo, if these funds can’t pay an incentive fee, then you are going to attract the worst managers to these funds. There is no incentive in these funds, other than to increase AuM, and that will attract a certain breed of financial managers that this industry could use less of.

There are traditional hedge funds which are now opening a liquid alt strategy to replicate their fund, so those may be a good option, even with the increased taxation and restrictions on leverage and liquidity. However, the funds which are new and have no track record should be avoided like the plague. Alts are a field where the top 10% of managers can outperform and do so on a consistent basis, and I don’t see why any of those managers would choose the mutual fund vehicle over a traditional private placement. My expectation is that the majority of these mutual funds will underperform, as they have over the past decade.

Also, are you hearing anything interesting about the SEC’s investigation of the 25 or so funds? I believe that there are strategies like managed futures which are using loopholes to get around the leverage restriction, are there any expectations of increased regulation or oversight?

Sure, there’s no doubt that the structure is more limited than an LP but that’s the name of the game. In some cases, the reduced leverage is offset by the fact of no 2 and 20 or 1 and 10. If you can get something in-between a long only mutual fund and a real hedge fund for 1.5% expense ratio and no performance fee, there are a lot of situations where that makes sense.

I think as a distribution channel, the mutual fund format makes more sense for equity hedge and macro, because these guys can run billions and billions without capacity concerns. You can get a quality manager here because it makes economic sense to get 1.5% on $10 billion rather than 2 and 20 on $500 million.

In event driven and relative value, the economies of scale might not make as much sense. Here, special care needs to taken in the due diligence process to understand the manager’s motives for launching a mutual fund. Also, they need to be able to give you a private fund track record with hypothetical modifications for leverage differences, etc. If they get sketchy, just walk away.

The SEC stuff I’m not worried about. We’ve already vetted our funds and understand the CFC details where applicable. I think the regulators are going to weed out the really egregious abusers of loopholes and it will end up being good for the segment in the long run.

Good stuff, i appreciate it

DoW, I have another question for you. Do you work with any liquid managed futures mutual funds? If so, can you point me in the direction of any that have been profitable for investors. I’m looking at MFTAX - Altegris Managed Futures Strategy Fund. Their fee’s are outragous and I suspect that it’s just the industry standard.

5.75% Sales charge upfront

2.14% fund mgmt fee

2% CTC mgmt fee

15-25% CTC incentive fee

The casual investor is going to have no idea what a CTC is or have any idea that the fees taken off the top are way larger than the 2.14% advertised by Altegris. Basically you’re taking the fees of a hedge fund, and adding an upfront sales charge and an extra 2.14% mgmt fee. This is OUTRAGEOUS! Seriously, this is why people think finance professionals are scum, how greedy can these guys be?!

I’ll refrain from giving out recommendations, but managed futures is one of the tougher segments because of the layering. Basically the controlled foreign corporation (CFC) structure within managed futures is required for this type of strategy because of regulatory constraints in a mutual fund; without the CFC structure the fund cannot achieve the required notional level of contract exposures to make the fund competitive in the managed futures space. Other types of strategies may not need CFCs. But, because of the CFC’s existence, there will naturally be a layer of fees that you cannot escape.

As for the upfront sales charge, there’s nothing that a low-money individual investor can do about that – sorry, I typically don’t consider those because I’m incorporating these at an institutional level and we have much more negotiating room with the fund companies to use other share classes. The individual investor definitely has to consider those, and this obviously reduces the attractiveness.

You should keep in mind that if you analyze these funds quantitatively, that the mutual fund return stream is already going to be in net terms – i.e., already taking into account the other fees except for the upfront fee. So, if those returns still look attractive versus whatever your benchmark is, then you should not worry about the disclosed fees as they have already been accounted for in your return series.

What types of research services / databases / subscriptions do you have access to? Perhaps I can point you in a better direction.

Right, so I understand that the fee’s are already taken out in the performance reported. I’ve looked at many funds, so I’m not just picking on MFTAX, but the strucuture is the same throughout and it’s a rediculous amount of fees. I modeled MFTAX’s structure and after 4 years, assuming a 10% rate of return in the underlying CFC fund, the investor is looking at an average rate of return of 4%.

I understand the structure and I understand the strategy. What I don’t understand is why these products exist and how any advisor could place a client into one. They need excellent performance to even return a decent amount to investors and take excessive amounts of risk. These funds do nothing but generate great fees for everyone involved. 6% upfront, 4% per year and 20% of profits. No wonder I can’t find any funds with meaningful returns over the past 5 years.

To give you some background, I work in alts research and am doing some work on the side to better understand the liquid alts space and hopefully find the strategies that work and those that don’t. I would like to assume that the strategies that can’t be well replicated wouldn’t exist, but I know better. My goal is to discover the strategies, like i believe i have with managed futures, where liquid alts wont work and my firm should not be offering them. Distressed debt and certain types of private equity come to mind, but i haven’t gotten that far yet. I’d like to be able to approach the mutual fund group and be able to say “hey guys, here’s what I found and here’s why I believe we shouldn’t be carrying X, Y and Z”.

I work with liquid alts. There’s a paper out there, I think from Cliffwater, regarding liquidity premiums and which alts strategies make sense in a 40 act mutual fund wrapper. I think it’s freely available, so a google search will likely lead you to it.

I just completed some work on managed futures mutual funds specifically, and you’re right, what some of these funds are charging is unreal. Avoid Altegris and others with similar structure, it’s robbery. A lot these funds use swaps to gain exposure to net of fee private vehicles as well, so there’s another layer of fees you don’t see. There are a few out there that are actually fee efficient. The big one is AQR. Natixis has one as well, and there’s one smaller, but very good, one from Aspen Partners.

Interesting and developing space for sure.

Thank you moto, I read those Cliffwater papers and they were very interesting.

I started this thread in the ‘investments’ section, since it’s probably more relevent over there.