Convergence Grows Between Hedge Funds and Mutual Funds

More hedge funds are looking to adopt ‘40 Act fund strategies as assets continue to flow into the sector. Inflows into alternative mutual funds in 2013 have already surpassed the $19.7 billion mark set in 2012, and these vehicles offer hedge funds a vastly expanded client base by reaching retail investors. On Wednesday evening in New York, Pershing, a wholly-owned subsidiary of BNY Mellon, hosted a panel discussion on this convergence between hedge funds and mutual funds.

“I think the term convergence that we use is kind of perfect for what we’re seeing, because it’s really not just one side versus the other pushing it; it really is both sides coming together,” said Frank Attalla, audit principal, Rothstein Kass.

Part of the discussion focused on what it looks like when a hedge fund adopts a ’40 Act structure, and the panelists agreed that this vehicle can in many ways resemble a hedge fund.

“Some people still have this perception that you can’t run a hedge fund in a mutual fund because of various limitations under the 1940 Act, [but] as a general matter, virtually every strategy can be run in the ‘40 Act platform,” said Matt Kerfoot, partner at the law firm Dechert, specializing in the alternative investment management industry.

As a result of increased transparency requirements for hedge funds, such as Dodd-Frank requiring hedge funds to register with the SEC, complying with the ’40 Act is less of a leap for funds, which explains some of the movement towards this sector. And while managers can not take the traditional performance fee that hedge funds usually charge, panelists said that an increased client base, such as direct contribution pension plans, is what makes ’40 Act funds so attractive.

Not only does there exist an opportunity for hedge funds by gaining management fees in this space, but end investors can also benefit from this new vehicle. “The opportunity exists for a better risk-adjusted return,” along with less volatility, said Kristina Labermeier, vice president, portfolio management at Hatteras Funds.

The panel also discussed the different formats for launches, which primarily comes down to either open-end funds or closed-end funds.

“Most managers that are running a relatively liquid strategy—global macro or managed futures—they will look at an open-end fund. It’s the easiest structure,” said Kerfoot. In order to invest in more illiquid assets, he says, managers should look at launching closed-end funds.

While the trend seems to be moving towards registered alternative funds, it’s still early in the game. “I’m a little bit skeptical in terms of the longevity,” said Kerfoot. Yet Labermeier disagreed: “Clearly, we think that it’s here to stay.” 

See GC’s Summer Plus 2013 magazine article “Heeding History” for more on this convergence