The development of ETFs, alternative-style mutual funds, and retailization of hedge funds is changing the landscape of investment companies.
ETFs have emerged as a significant investment vehicle and a driving force behind the changing landscape. Primarily directional in nature, ETFs are based on indexes or quantitative styles. They are excellent for gaining access to the stock market, any sector, any country, any bond, and any investment strategy that provides absolute access to a market in either a long or short basis. ETFs have largely replaced mutual funds for active traders and asset allocators. The expense ratios of ETFs are lower because they are primarily index based and do not require the investment adviser expertise of active portfolio management. The ability to trade throughout the day at a value that closely follows the net asset value of the underlying holdings is a tremendous advantage of ETFs. These vehicles have become a valuable tool in the formation of actively managed mutual funds that are replacing the traditional directional mutual funds.
Gemini Fund Services client and NAAIM President, Ian Naismith, agrees with my take on ETF’s. “After more than a decade of mainly trading individual securities, Tony and I formed Sarasota Capital Strategies in 2002 to specifically trade ETFs tracking various indexes, sectors, asset classes – and mutual funds that employed leverage, inverse direction, and alternative exposure. We had experience trading ETF’s in the mid to late 1990’s and believed they were the wave of the future. Throughout the 2000’s we saw and built strategies based on gaps in the marketplace that did not exist in any product offerings. In 2009, we launched our first product that is a mixture of technical analysis/active management of ETFs representing an underused asset class in the wrapper of a mutual fund – The Currency Strategies Fund. The beauty of this is, if we can do it – anybody can do it. Like you, we have good friends in the mutual fund world that created funds using turn-key fund administrators and have put their vision to work. We are absolute believers that the future marketplace will and should continue a metamorphosis towards products and services that lean heavily to the alternative space while offering fair costs to the advisor community."
As President of Gemini Fund Services, I am excited by the opportunities I foresee, based on my belief that mutual funds of the next decade will become more dynamic and be less restrained by the style boxes created by rating services. Mutual funds will strive for absolute return, hedged strategies, and risk reduction. Investors scarred by multiple bubbles and loss of wealth will seek mutual funds that are judged in absolute terms and periods of large losses will be less tolerated. In many ways, mutual funds will replace most hedge funds currently used in advisor’s strategies and will force hedge funds to seek other markets and strategies. We are already seeing hedge funds converting to mutual funds and many hedge fund advisors are creating new mutual funds. Increased regulation on non-registered products will continue to blur the lines between hedge fund and mutual funds. The acceptance of paying a 2% management fee and 20% of profits to a hedge fund manager that produces strategies available in mutual funds will fade. Mutual funds will produce efficiencies in hedge fund-like strategies that will mirror those produced when the days of stock brokers making $100 per trade were replaced by the current on-line services that charge $10 or less.
Hedge funds will continue to provide a crucial role in the investment community. They will still provide access to markets that are restricted to other investment companies, such as illiquid investments, real estate, private equity and other investment classes and will also continue to be an investment vehicle for the super wealthy. I believe the hedge fund advisers that have proven track records of superior performance will continue to raise assets and charge obscene fees. However, the retail market will be rightfully assumed by mutual funds and investor caution and regulation will eliminate many of the existing equity hedge funds.
The investment landscape is changing. Only time will tell us exactly how but one thing I know is true…it will continue to change into the foreseeable future and advisors must be flexible and willing to embrace the changes.
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