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A Silver Lining of Compressed Fees: Alts Are Thriving

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Investment advisors have seen an increased squeeze not only in their own compensation, but also with those in whom they invest. The new reality is if money managers want access to investors’ money, fees must be negotiated. This works in favor of the RIA who has seen new investment opportunities open with reduction of fees, especially with alternative investments.

Fee reduction is one factor that has attracted big money to alternative investments. In a recent Preqin survey on managed futures, managers saw roughly 29% of new investments in 2017 coming from public and private pension and endowment funds. Another 20% may come from family offices. There are several reasons these big institutional funds have included alternative strategies, especially managed futures, as part of their portfolios. These include noncorrelation to traditional asset classes, enhanced diversification, reduced portfolio volatility, increased risk management and potentially higher returns.

In fact, a 2015 McKinsey study showed alternative products command higher revenues, stating, “In 2013, alternatives accounted for about 12% of global industry assets but generated one-third of revenues. By 2020, alternatives will comprise about 15% of global industry assets and produce up to 40% of industry revenues, as the category continues to siphon flows from traditional products.”

Overall, from 2005 through 2013, alternative investments have grown twice as fast as traditional investments (10.7% vs. 5.4%), according the McKinsey study, although traditional investments still own the lion’s share of all investments ($56.7 trillion vs. $7.2 trillion). Within all alternative investments are many ways to invest, including:

  • ’40 Act managed futures funds, which have more than $26 billion in AUM as of March, according to Morningstar, and
  • through direct investment, that is investing in a managed futures account or trader fund, which is what many big investors utilize.

’40 Act Managed Futures Funds

AQR Capital is, arguably, the firm that put ’40 Act managed futures funds on the map. The firm has $244 billion under management overall as of March 7, 2017. AQR Capital’s expense ratio for its largest futures fund, Managed Futures Strategy Fund [AQMIX], is 1.20%. Jason Kephart, analyst with Morningstar, says he hasn’t seen a notable drop in ’40 Act managed futures fees overall, and that includes AQR’s, which have remained relatively flat. Morningstar reports the average expense ratio of a U.S. open-end ’40 Act managed futures fund is 1.96%.

But not all ’40 Act managed futures funds are created equal when it comes to fees, Kephart notes. For example, some use total return swaps to pay outside manager incentive fees, which adds to the fee structure. For example, he notes the Altegris Futures Evolution Strategy [EVOAX] fund uses the total return swap method, and has a 2% expense ratio as well as a 1% management and 20% incentive fee. Kephart says forcing the investor to find the fee structure in the “fine print” is one of the “worst practices” in the fund industry. Part of the reason for higher fees, he notes, is the use outside or submanagers. AQR managers are all in-house, which reduces the payment structure. That said, Altegris recently launched a new alternative mutual fund with GSA Capital that will incorporate a flat-fee structure of 1.35% and aim for a 14% volatility structure.

Direct Investment

RIAs also can access a managed futures manager directly, typically the road taken by pension and endowment funds. This is where a compression of fees has definitely taken place, says David Young, president of Gemini Alternative Funds. Young notes there’s always been a “level of difficulty” for investment advisors to find commodity trading advisors and access how information is reported back to the RIA. He agrees there was a wave of growth in ’40 Act managed futures funds, but now they are seeing more direct investment by RIAs.

Gemini’s Galaxy platform works with its sister company Orion, which has access to some 1,000 RIAs, to provide a desktop application that allows users to research and select potential trading advisors and get educational material including videos on managed futures investments. He says “there’s a realization that mutual funds are expensive, and they can get a better return with a direct investment with a single or multi-managers.”

Today, Gemini has $1 billion in managed futures investments on its platform, up from $250 million in 2015, highlighting the interest from RIAs in this asset class. Fees range from 125 to 150 basis points. Young says CTAs on its platform have been able to compress their fees largely because Gemini handles their operational costs so traders can focus on their research and trading.

“The reality is compression of fees will continue; we’re not going back [to 2% management and 20% incentive],” he says. “[CTAs] say they like to deliver everything, but the investor looks [mainly] at it for performance.”

Annette Casenave, principal of A. Casenave LLC, who structures alternative funds, cautions investors to make sure they look beyond fees and review all aspects of funds when making a decision. “Investors need to look at performance, managers, history, investment strategy, everything, in addition to fees,” she says. Also, she urges RIAs to ask managers and funds to outline all fees. For example, a fee cap may not include other fund costs, she says.

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