Unlocking Real Value Blog

Poll: Alt Mutual Funds to Face More Scrutiny

Published on May 19, 2010 – Ignites – An Information Service of Money-Media, a Financial Times Company
By Gregory Shulas

Mutual funds that embrace alternative investment strategies will face tougher scrutiny in the wake of the May 6 “flash crash.” That’s according to a vast majority of Ignites poll respondents.

Roughly 74%, or 124 voters, said mutual funds that use derivatives will face tougher reviews in the months ahead from regulators and investors. That made it the most popular option selected in an Ignites survey that asked whether the mysterious market gyration will result in more scrutiny of alt-style mutual funds.

Of the majority vote, 43%, or 72 voters, expect a moderate increase in scrutiny, while 31%, or 52 voters, said a significant increase in oversight awaits such funds.

In contrast, 26%, or 44 voters, said it will be business as usual for mutual funds that use alternative strategies, such as futures contracts, swaps or commodities. That made that option the survey’s least popular choice.

Waddell & Reed’s Ivy Asset Strategy fund came under a microscope after Reuters reported that it was responsible for an unusually large wave of futures selling that allegedly contributed to the “flash crash.”

The Kansas City area-based firm unloaded 75,000 e-mini contracts, or S&P 500 derivatives, during the 20-minute equities plunge, according to a Chicago Mercantile Exchange document that Reuters obtained. The document apparently identified Waddell as the unnamed trader that Commodities Futures Trading Commission chairman Gary Gensler mentioned in congressional testimony this month.

Waddell & Reed has refuted claims that it was responsible for the disruption. The company has cited an analysis showing how its trading accounted for 1% of the volume traded in the S&P 500 on May 6. The gyration at one point caused the Dow Jones Industrial Average to fall by nearly 1,000 points while temporarily pushing well-established companies into penny stocks.

Regardless of what investigators ultimately find, the incident is spurring questions about the effect alt-oriented funds can have on the market, acknowledges Andy Klausner, principal of AK Advisory Partners, a Boston-based consulting firm.

Until the pending financial reform bill is finalized, it’s hard to know where regulators will stand on retail funds that emphasize derivatives, Klausner says. A legitimate concern for the industry is whether Congress and other government agencies will rush to judgment and impose unnecessary restrictions on alt-oriented products, he says.

“I think there is still so much uncertainty with what happened on May 6,” Klausner says. “Let’s hope regulators don’t react too quickly to what happened. We… need to determine what exactly happened first.”

Alternative-oriented mutual funds have grown in popularity as financial advisors have sought exposure to asset classes that have low correlations with traditional equity strategies. By accessing alternatives in a mutual fund structure, investors receive lower fees and more transparency than they would in a hedge fund, industry experts argue. Further, alt-style mutual funds are free of the hedge fund gates that lock up clients’ assets until performance recovers.

Nearly 170 readers participated in the survey as of 3 p.m. Tuesday. The survey is an unscientific sampling of Ignites subscribers, who include money managers, service providers and financial advisors. Participants were self-selected and voted only once.

Leave a Reply