"Hedged mutual funds can both reduce losses or make money. They are designed to return a small amount in any market. On balance, they add choice and selection to a client's menu," Longo said.
Further enhancing competition in the alternative mutual fund space is the recent U.S. Securities and Exchange Commission’s announcement that it was partially lifting its ban on derivatives.
“Most of the alternative mutual funds on the market today use derivatives as a hedging tool primarily. As a result of the ban being lifted, we will see more ETF alternative mutual funds in the future,” Papagiannis said. “ETFs are a lower cost vehicle so there will be more price competition there for mutual fund firms offering alternative mutual funds.”
Characteristics of alternative investment strategies include some mix of shorting or hedging, the inclusion of futures or derivatives, or non-standard techniques such as illiquid securities and leverage, which are limited under mutual fund regulation.
“Liquid alternatives or alternative mutual funds provide access to alternative strategies with greater investor protection because registered investment companies are highly regulated. For example, investor assets must be held in a segregated and protected fashion,” said Lake. “Daily liquidity is a mandate so there’s strict limitations on illiquid securities and leverage. Finally, regulation makes it difficult for a manager to charge a hedge fund style incentive fee so alternative mutual funds are also low cost.”
In March 2010, the SEC placed a moratorium on all applications from firms looking to open ETFs that used derivatives and credit default swaps. Since the ban was lifted on Thursday December 6, mutual fund companies can more easily enter the actively managed ETF market while using derivatives.