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Should I Go With the Flow Into Liquid Alts? (Emerging Managers Part One)

By Frank Attalla, CPA, and Marc J. Wolf, CPA, Rothstein Kass | Tuesday, April 8th, 2014

This week for our Emerging Managers Article Insight Series we have an article published by the Rothstein Kass Institute, the firm’s industry think tank, which outlines a set of important questions alternative investment managers should ask themselves if they’re weighing a move into the growing liquid alternatives market. The article, which will be presented in two parts, offers insights that can help managers determine whether a registered product is right for them, and provides tips on how to best implement their strategy if they decide to make the move. Read more articles from the Series HERE.

Articles for Hedge Fund ManagersAs regulatory requirements become more complex and onerous in the alternative investment space, there is clearly an evolution taking place in the market. There is an ongoing trend toward adding registered or retail products among many hedge fund managers. They are seeking new structures to bring their strategies to market while putting themselves in the best position to tap retail investors and wealth advisors in the new competitive landscape.
It’s no secret that a significant amount of capital is looking to move into the alternative investment space – just look at the numbers. According to Citigroup, assets in liquid alternative funds have surged from $95 billion in 2008 to more than $300 billion last year. Citi estimates that number will hit $1 trillion by 2017.
If you look at the trajectory, what seems to be clear is that liquid alternatives are here to stay. What may not be so obvious to some alternative managers is whether they should stay on the private fund side or follow the asset flow into the retail space by adding additional product offerings. It’s not a move that should be taken lightly.
Managers have to make smart, informed decisions about whether a registered product is right for them, and how they can best implement the strategy if they decide to make the move. There are many questions that need to be answered, and many options that need to be considered before making such a critical decision.
To help managers make more informed decisions in the new liquid alternatives reality, Rothstein Kass has compiled a set of important questions managers must ask themselves, and other critical considerations that should be part of their decision-making process.
1.Will a registered product cannibalize my existing private fund business?
For hedge fund managers, the potential to tap into the mass affluent market through retail distribution channels is extremely enticing, but not if it comes at the expense of their current business. The goal of launching a liquid alt fund should be to gain access to a new pool of investors that could not be reached with a private fund, not to move current investors from one product into another. Managers have to take a hard look at how a registered product will impact their existing private fund business.
For example:

  • Will it be additive or will be it be competitive?

  • Can you clearly articulate the differences between the product offerings and the value to different investor segments? If not, then it is unlikely you will be successful long-term.

If investors feel they can get the same diversification and upside in a retail product — without paying the performance fees of a hedge fund — why wouldn’t they simply move their assets from one product to another at the first opportunity?
Beyond investor perception, managers must also consider operational resources and other elements that may take away from the success of a current business. It may seem like a product extension but, in reality, launching a liquid alt fund is like launching a new business that requires a:

  • Well-thought-out business plan,

  • Thorough competitive analysis, and

  • Realistic view of what impact that new business will have on your existing revenue.

 2. Will my strategy fit inside a mutual fund?
This may seem like a simple question, and for some managers it is. The reality is that most strategies can fit into a mutual fund or liquid alt model, as long as:

  • You have the proper structure for trading commodities,

  • You don’t have a significant amount of illiquid assets, or

  • You’re not highly levered.

 And, in some cases, even if managers do have significant illiquid assets, they can utilize a listed or unlisted closed-end fund and still reach a new pool of investors.
So, instead of thinking of this as simply a yes or no question, this decision may come down to a question of nuance. The following are all questions that managers should not only consider, but talk through with their team of experts:

  • Do you fully understand what you can or cannot do from a strategy standpoint inside a registered vehicle?

  • Do you understand how you can or should alter your strategy to be most effective in the registered arena?

  • Are you aware of the registered product structures that would be most conducive to your particular strategy?

 The reality is there is no typical alternative mutual fund, and there is no cookie-cutter approach to being successful in the liquid alts space.
3. Do I understand the distribution landscape?
Distribution is critical to the success of any investment product, but in the increasingly competitive world of liquid alternatives it’s even more so. Managers can have the best investment strategy out there, but if they do not have a sound distribution strategy with the right distribution partners and channels, it will not matter.
What managers have to understand is that retail distribution is a whole different animal than private fund distribution. Hedge fund distribution is more relationship-driven, while mutual fund distribution requires systematic institutional selling. Mutual fund distribution requires managers to consider everything from strategic product positioning and pricing to understanding the peer group that a fund is competing against.
Managers have to be confident that they can execute their strategy effectively either by themselves or with a trusted partner.
4. Should I use a stand-alone trust or a series trust? If a series trust, how do I choose the right one?
Organizing a registrant and launching a mutual fund is a complex process with a lot of requirements. The first decision that managers need to make is whether they will set up their fund as a stand-alone trust or through a series trust. The decision often comes down to weighing multiple factors such as cost, time to market and control over the process.
With a series trust, the regulatory compliance and operational structure is already in place, which can reduce startup costs, administrative burdens, operational costs and, ultimately, time to market for managers. The trade-off is that the manager is fitting into an existing structure and inheriting an existing board that might not be tailored for their specific strategy.
If you do decide to go the series trust route, it’s important to understand that there are a growing number of options and there can be huge disparity when it comes to everything from expertise and assets to costs and technology. So, you have to do your series trust “due diligence.” For example:

  • Talk to managers who are in the trust already.

  • Look at the trust sponsor’s experience.

  • Gain a full understanding of the expertise and reputation of the board, the audit firm and the legal counsel.

  • Understand the distribution channels being utilized.

These are important factors — and questions that need to be answered — because choosing the right series trust is a critical decision as there is no one-size-fits-all option. Also, although not impossible, it is not always an easy task to spin a fund out of a series trust in the future.
5. Is a registered fund too expensive?
While many managers may think the answer to this question is yes, this response may be anchored more in perception than reality. The operational, compliance and reporting responsibilities may seem more onerous and costly in a registered fund, but the reality is that they are just different. If a manager works with the right partners to put the right infrastructure, processes and controls in place, the operational efficiencies and cost savings will follow.

Come back Thursday for part two of the article or subscribe to Hedge IT and have it delivered to your inbox.

About the Authors

Frank Attalla is a principal at Rothstein Kass, located in the firm’s Roseland, N.J., office. He has over 15 years of experience exclusively in the financial services industry. He specializes in audit and tax services for a variety of investment partnership structures, including domestic and offshore funds, master-feeder structures, funds of funds, and registered investment companies. Frank is a certified public accountant in New Jersey and New York.
Marc Wolf is an audit principal in Rothstein Kass’ Beverly Hills office. Marc’s areas of specialization are focused within the firm’s Financial Services Group, specifically hedge funds, regulated investment companies (RICs), commodity pools, real estate, private equity and other types of investment vehicles, broker-dealers, private foundations and family offices. He is a certified public accountant in California, Colorado, New Jersey, New York and Texas.

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