18.2.8 Alternative Funds

18.2.8 Alternative Funds

Introduction to Alternative Funds

Introduced as a category in 2019, Alternative Funds leverage strategies that traditional mutual funds are not permitted to utilize such as short selling and other forms of leverage. These funds are designed to employ both speculative and hedging strategies. Unlike mutual funds that require a simplified prospectus, alternative funds operate under a different set of guidelines.

Characteristics of Alternative Funds

• Short Selling: This involves selling securities borrowed from a third party with the hope of buying them back at a lower price in the future. It is a speculative strategy used for generating returns in a declining market.
• Leverage: The use of borrowed capital to amplify the potential return of an investment. While this can magnify gains, it also increases the potential risk of loss.
• Hedging: Strategies designed to offset potential losses in other investments. Hedging is typically conducted using derivatives such as options and futures.

Subcategories of Alternative Funds

Alternative funds are further divided into the following subcategories:

1. Alternative Equity Focused: Investments are primarily in equity securities but with the permission to engage in short selling and leverage.
2. Alternative Credit Focused: Investments primarily in credit instruments such as bonds and other fixed income securities with the use of leverage and short selling for additional opportunities.
3. Alternative Multi-Strategy: Incorporates a variety of strategies across different asset classes and investment vehicles to achieve its investment goals.
4. Alternative Market Neutral: Seeks to profit irrespective of market direction by offsetting long positions with short positions.
5. Alternative Other: Includes unique strategies not captured in other subcategories, providing broad flexibility.

For further details on these funds, refer to Chapter 20 and Chapter 21.

Frequently Asked Questions

What is the main difference between alternative funds and mutual funds?

Alternative funds utilize advanced investment strategies such as short selling and leverage which are not permissible for traditional mutual funds.

Are alternative funds riskier than mutual funds?

While potential returns can be higher, alternative funds generally carry greater risk due to the use of leverage and speculative strategies.

Glossary

• Short Selling: Selling securities you do not own, anticipating that their price will decline so you can buy them back cheaper later.
• Leverage: Using borrowed capital to increase the potential return on investment.
• Hedging: Implementing strategies to offset potential losses in other investments.

Key Takeaways

• Alternative funds were introduced in 2019 and pursue strategies like short selling and leverage.
• These funds aim to generate returns through both speculative and hedging techniques.
• Divided into subcategories including equity-focused, credit-focused, multi-strategy, market-neutral, and others.

Summary

In summary, alternative funds represent a newer category of investment options that offer both unique opportunities and risks. Leveraging different financial instruments and strategies, these funds are designed for a more sophisticated investment approach. With multiple subcategories, they provide diverse pathways ranging from equity and credit focus to multi-strategy and market-neutral approaches. For those still unfamiliar with alternative funds, reviewing Chapters 20 and 21 will provide further insight.

To better visualize this, let’s incorporate a simple chart that categorizes alternative funds:

    graph TD;
	  A[Alternative Funds] --> B[Alternative Equity Focused]
	  A --> C[Alternative Credit Focused]
	  A --> D[Alternative Multi-Strategy]
	  A --> E[Alternative Market Neutral]
	  A --> F[Alternative Other]

Understanding these unique investment vehicles can add substantial breadth to your investment knowledge and strategy. More information on these funds and how they can be integrated into an investment portfolio is elaborated upon in subsequent chapters.