SEC’s Stein Takes Aim at Alternative Mutual Funds

Mutual Funds

Securities and Exchange Commissioner Kara Stein is starting to see “some cracks in the foundation” of the regulatory framework that has governed mutual funds for 75 years, and it has her concerned.

In prepared comments made The Brookings Institution celebration of the 75th anniversary of the Investment Company Act of 1940, she specifically focused on alternative mutual funds, noting that sassets under management in alternative mutual funds have exploded in recent years.

“In 2008, there were approximately $46 billion in assets under management for these funds,” she said.  “By the end of 2014, the number had surged to over $311 billion in assets under management. This is an increase of over 575%. We continue to see more investment firms pressing to move into this area. An official at the Commission had an interesting description for alternative mutual funds.  He called them “bright, new, shiny objects in the marketplace that are also very sharp and fraught with risk.”

She added that alternative mutual funds have gradually drifted away from the intent and foundational principles of the Investment Company Act.

“For a long time, mutual fund managers did not suggest that they could manage a fund in a way that mimicked the return of a top hedge fund.  It was simply understood that the liquidity and leverage restrictions contained in the Investment Company Act were prohibitive, and would not allow for a true hedge fund type strategy.  If you wanted the potential upside that a hedge fund strategy might give you, you had to accept the downside of a certain level of illiquidity with your investment, which you could not do within a registered fund.”

Yet, today, she countered, alternative mutual funds promising the upside of hedge fund investments with the liquidity of traditional mutual funds are “all the rage.”

“I think that this trend should give everyone pause, and regulators and the public need to be asking questions about this development,” she concluded. “As I mentioned earlier, the Commission is at the beginning stages of a rules initiative focused on asset managers and registered funds. In particular, the Commission and staff will be considering liquidity and derivatives. This initiative presents a much needed opportunity to take a holistic look at how the Investment Company Act is currently functioning and if it can be enhanced and updated going forward.”

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John Sullivan
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With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.

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