Home ListingJune 16, 2015

Liquid Alts, Prepare to Be Scrutinized

The heavily-advertised products operate in a regulatory "gray area," an SEC commissioner says.

Reported by Featured Author

Alternative mutual funds—or liquid alts—have escaped scrutiny for long enough, according to a US Securities and Exchange Commission (SEC) official.

“These funds often operate in a gray area of mutual fund regulation,” SEC Commissioner Kara Stein said Monday in a speech at the Brookings Institution, a policy think tank in Washington, DC.

“Promising high liquidity—which all mutual funds must do—on illiquid assets that have not traditionally been a part of mutual funds does not seem in keeping with the intent of the Investment Company Act,” Stein continued.

“I hope that as the commission considers action in the area of liquidity, it asks hard questions about new and innovative products, as well as emerging risks. Do the retail investors investing in these funds truly understand and appreciate the liquidity of the fund?”

Stein noted the difficulty of defining what, precisely, counts as a liquid alt product, and drew the boundaries widely. If the regulator agrees with Stein, any manager running an exchange-traded or mutual fund using non-traditional asset classes or strategies, illiquid assets, or relying heavily on derivatives should brace for extra SEC attention.

The sector has been one of finance’s great growth areas over the past several years. Between 2008 and the end of 2014, alternative mutual fund assets increased by more than 575% to $311 billion, according to Morningstar data.

Now, Stein argued, it’s time for regulators to catch up.

“Today, alternative mutual funds promising the upside of hedge fund investments with the liquidity of traditional mutual funds are all the rage,” she told the audience. “I think that this trend should give everyone pause, and regulators and the public need to be asking questions about this development.”

Stein has held senior financial advisory positions with a number of high-profile federal lawmakers and drafted significant portions of the Dodd-Frank Act, according to the SEC. In 2013, President Barack Obama appointed her to one of five commissioner roles at the regulatory agency.

Read Stein’s full speech: “Mutual Funds: The Next 75 Years.”