Not surprising to many, the SEC is planning to undertake examinations of alternative mutual funds with a particular interest in their leverage levels, use of derivatives and overall risk. An article that appeared on Bloomberg yesterday indicates that the SEC will look closely at 25 funds across multiple alternative fund types, and will take roughly six months to complete their examinations. An evaluation of the funds by the SEC could bode well for the industry assuming that the SEC gains comfort that the funds are not in violation of the rules and regulations that govern mutual funds. Many of the alternative mutual funds make extensive use of derivative instruments, such as futures and options, that can provide leveraged exposure to different asset classes and other financial products such as exchange traded funds.
These exams follow several industry warnings from securities regulators over the past year. Last June, the Financial Industry Regulatory Authority (FINRA) issued an investor alert on alternative mutual funds, where they titled the alert, “Alternative Mutual Funds are Not Your Typical Mutual Funds.” In this alert, they warned individual investors to carefully consider the complexity of these funds before investing: “Investors should fully understand the strategies and risks of any alternative mutual fund they are considering. FINRA is warning investors to carefully consider not only how an alt fund works, but how it might fit into their overall portfolio before investing.”
In January of this year, the SEC issued a risk alert to investment advisors urging them to take extra care with regard to their due diligence efforts on alternative investments. While that statement did not specifically mention alternative mutual funds, it was clear that advisors need to have specific policies in place for conducting research on the full range of alternative investments, and to clearly communicate with their clients the methods they used to perform their due diligence.
The overall theme at the SEC, and in conjunction with FINRA, is one of caution as alternative investments become more mainstream in the retail market.