What Are Alternative Mutual Funds?

By Julie Mendel, Senior Product Manager
Nov 15, 2019
what are alternative mutual funds

A particularly complex product is the alternative mutual fund.  Alternative mutual funds or "alt" funds are publicly offered, SEC-registered mutual funds that hold non-traditional investments or use complex investment and trading strategies. Regulators are warning investors considering alt funds to be aware of their unique characteristics and risks. These risks include:

  • Alt funds often try to minimize swings in value to reduce risk by including a wide range of investment objectives designed to meet various investment needs and using complex trading strategies. This strategy is also believed to reduce risks because investments are spread among different asset types. This complexity can make it difficult for the average investor to understand.
  • Alt funds often investing in non-traditional investments such as global real estate, start-up companies, or commodities such as gold or oil to reach their objectives.These investments are also complex.

  • Alt funds often use investment and trading strategies that are more complex than traditional mutual funds such as selling stocks short, using derivatives, or following "absolute return" or “market neutral” strategies that seek positive returns even when the stock markets fall.These strategies can result in higher costs and additional risks than traditionally managed funds.

Because of the risk to investor and complexity of the products, FINRA recommends that firms refer to alt funds based on their specific strategies, instead of bundling them under one umbrella category. FINRA also requires firms to ensure that their communications with the public regarding alternative funds present a fair and balanced picture of both the risks and benefits of the funds and may not omit any material facts or qualifications.

One alt fund in particular, the ETF, is highly complex and while FINRA recognizes that ETFs are useful in some sophisticated trading strategies, they are still highly complex financial products designed to achieve stated objectives on a daily basis. As a result, the effects of compounding their performance over longer periods of time can often differ significantly from their stated daily objective. Because of this, these ETFS may be unsuitable for retail investors who plan to hold them for longer than one trading session. As a result, FINRA reminds members that before recommending the purchase, sale or exchange of any security, they must have a reasonable basis for believing that the transaction is suitable for the customer to whom it is recommended. To make that determination, you must understand all terms and features of the product recommended and consideration of how the fund is designed to perform, how it achieves that objective, and the impact on performance from market volatility, among other things.

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