Multi-Manager Funds: What’s the Difference in Fund Structures?

Multi-manager hedge funds were designed to provide investors with access to a diversified portfolio of hedge fund strategies, seeking to take advantage of distinctive sources of alpha from each underlying hedge fund held within the portfolio. Having been introduced 30 years ago, multi-manager hedge funds were historically set-up as private partnerships, and today that is still their most prevalent form.

However, these funds can also be structured as a closed-end tender offer (TO) fund, and more recently, in a traditional mutual fund format.  While these funds may look and sound relatively similar, each has their own unique characteristics and structure that may be appropriate for different investor profiles.

Structures of Multi-Manager Hedge Funds

Although both are registered as investment companies (e.g. “RICs”) under the Investment Company Act of 1940 (the ‘40 Act), the term ’40 Act fund is typically used to describe a mutual fund whereas the term RIC is generally used when referring to the closed-end TO fund structure.

A ’40 Act mutual fund provides daily liquidity to investors as opposed to the periodic liquidity offered by a closed-end TO fund (or RIC).  Because of this structure, investments held by hedge fund strategies in a mutual fund must be able to be easily liquidated in order to provide daily liquidity.  As such, these funds are generally limited to the most liquid hedge fund strategies including, long/short equity, market-neutral, global macro, and managed futures. Other less liquid strategies, such as fundamental long-short equity, distressed credit, activist investing, and fixed income relative value, among others, are much more difficult to liquidate and thus rarely included in ’40 Act mutual funds.

Liquidity requirements also impact the way in which these fund structures are able to invest with a hedge fund manager. Because RICs offer periodic liquidity, they can invest directly into a hedge fund manager’s private fund and are not restricted by the liquidity profile of any given strategy. On the other hand, a multi-manager mutual fund’s portfolio must be liquid, and therefore, a separately managed account with each hedge fund manager must be opened.

Although separately managed accounts may sound appealing, not all hedge fund managers are willing to accommodate a daily liquidity offering. When comparing the hedge fund line-up for a manager that manages both a multi-manager mutual fund and a multi-manager closed-end TO fund, the overlap between the two funds will likely be quite low despite a similar investment objective. Even if both portfolios contain the same underlying hedge fund manager, one may find that the strategy implemented for the multi-manager mutual fund may be a diluted or simplified version of the manager’s hedge fund strategy due to the investment limitations applicable to mutual funds.

Conclusion

A multi-manager hedge fund’s objective is to provide investors with a diversified portfolio of hedge fund strategies that seek to take advantage of distinctive sources of alpha through each underlying hedge fund held within the portfolio.  Today, many consider accessing these portfolios of hedge funds either in a mutual fund format or via a RIC (closed-end TO fund).

For investors who are not accredited or cannot meet the investment minimums of a RIC, alternative mutual funds can provide a solution for diversification beyond traditionally managed stock and bond portfolios. However, the diversification argument as well as the return opportunity may be reduced for those investors, as a smaller number of hedge fund strategies can be utilized within a mutual fund structure.  Further, the modest supply of top-tier hedge fund managers willing to be included in a mutual fund structure creates significant negative selection bias.  Consequently, eligible investors (e.g. accredited investors) may find that a multi-manager closed-end TO fund may be a better option to access hedge fund strategies despite more limited liquidity than mutual finds.

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The information contained herein does not constitute an offer to sell or a solicitation of an offer to purchase any securities and is not intended to provide investment advice. Before investing in any investment product you should consult with your financial, tax and/or legal advisors.