Regulated Alternative Funds: The New Conventional - SEI

Regulated Alternative Funds:
The New Conventional

Preface
One of the most visible changes in the global investment management industry post-crisis
has been the new, sustained demand for “alternative” strategies and asset classes in retailfriendly
fund structures. SEI and Strategic Insight first examined the growth of alternative
mutual funds in a 2010 report, Exotic to Mainstream: Growth of Alternative Mutual Funds
in the U.S. and Europe. The further growth that paper predicted has come to pass, and
many other conclusions still hold true today:
• The trend toward “mainstream alternatives” holds substantial appeal for investment
managers. For alternative managers, offering their strategies in a mutual fund structure
opens up a substantially broader market opportunity. Meanwhile, traditional managers
see an opportunity for increased fund flows, and potentially higher margins.
• A diverse group of strategies, including long/short and global tactical asset allocation,
and a varied group of managers are already experiencing success with these products.
Sponsors continue to be geographically dispersed throughout Europe and the U.S.,
and are beginning to emerge in Asia.
• Managers entering this space must address expertise, regulatory, operational, and
distribution considerations. Many of these factors can be central to the retail alternative
effort, whether it’s a traditional manager who will need to acquire shorting skills, a firm
whose strategies will have to be adapted to UCITS requirements, or an alternatives
manager requiring a new, retail sales presence. The challenges can be daunting, but
the opportunities in this fast-growing segment of the market are substantial.

Executive Summary
In what is beginning to seem like the distant past, a
clear line had once separated traditional and alternative
investment products. But as investors faced multiple
market crises and rising volatility, fund managers
responded with a range of innovative products
designed to better manage volatility and offer
alternatives to long-only investing in traditional markets.
As investor segments and products converge,
alternative strategies are increasingly being packaged
within registered fund structures originally designed for
retail buyers, but also used by institutions and other
fund selectors. A growing number of alternative funds
are being launched as UCITS (Undertaking for
Collective Investment in Transferable Securities), a fund
vehicle accepted for sale in countries throughout the
European Union and many other nations. Alternatives
also are becoming more prominent within U.S. mutual
funds (registered under the Investment Company Act of
1940 or, in some cases, under the Securities Act of
1933). The growing popularity of these funds is clearly
evident in strong asset flows, product proliferation, and
a growing presence in Asian markets.
One factor driving the popularity of alternative UCITS
and mutual funds is the detailed requirements around
risk measurement and management, liquidity,
counterparty diversification, and limits on leverage.
However, the increased use of derivatives and their
associated counterparty and operational risks continue
to concern investors and regulators alike. The regulatory
environment remains in flux as new rules on hedge
funds take shape in Europe, and as the framework
around UCITS gets reviewed amidst the expansion of
more complex products. Yet this too is encouraging
further innovation.
Meanwhile, new frontiers are emerging. Europe and the
U.S. have led the way in the adoption of alternative
strategies, but other markets are developing a taste for
non-correlated funds. One of the biggest retail fund
launches in Japan this year was an alternative
managed futures strategy. Demand for alternatives is
growing among sovereign wealth funds and national
pension funds in Asia, Latin America and the Middle
East. Wealthy individual investors around the world are
also expected to consider alternatives more seriously
after their recent experiences with traditional asset
classes. Although U.S. institutions and high net worth
individuals (HNWIs) can access hedge funds and
alternatives directly, they may see the benefits of
sourcing such strategies through regulated structures,
just as their European counterparts have done.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
“ Although U.S. institutions and high net worth
individuals (HNWIs) can access hedge funds and
alternatives directly, they may see the benefits
of sourcing such strategies through regulated
structures, just as their European counterparts
have done. ”
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REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Key Findings
The evolution of investment philosophies and strategies is causing previously distinct investor segments and products
to converge. The trend of packaging alternative investment strategies within mutual funds and UCITS continues
unabated, with new products being introduced regularly and asset flows gaining momentum. Regulated Alternative
Funds: The New Conventional offers an updated look at the dynamics of this rapidly evolving and maturing market,
and shows how the popularity of these funds continues to rise around the world. Key findings include:
• Global financial crises and continued market volatility using alternative strategies and managing a combined
have transformed attitudes toward investing. As
$254 billion of assets.
managers respond to the evolving needs of investors
• Alternative strategies through U.S. mutual funds and
and their advisors, previously segregated products
ETFs drew $39 billion in net inflows in the first eight
and segments are converging.
months of 2011, on pace to come near 2010’s $65
• The convergence is seen in growing capital flows billion. By the end of August 2011, the U.S. had
into regulated alternative investment products, most roughly 730 alternative mutual funds and ETFs,
often in the form of UCITS funds and U.S.-registered 118 of which had been launched in the first eight
mutual funds.
months alone.
• During the first eight months of 2011, more than $61
billion poured into regulated funds using alternative
strategies. With no slowdown of demand in sight,
assets in alternative mutual funds and UCITS could
hit the $1 trillion mark by 2014.
• Growth is being driven by several factors. Investors
are looking for ways to bolster portfolio performance,
protect capital, and lower volatility. Traditional
managers want to tap higher-fee areas. Alternative
managers would like to expand and diversify their
client base.
• Alternative strategies still account for a small portion
of the UCITS and U.S. mutual fund markets, but
they continue to capture increased market share.
They are also the most popular category in product
development pipelines.
• Alternative strategies inside UCITS attracted $22
billion of net new flows in 2011 through August,
following $50 billion in full-year 2010. Up until this
summer’s volatility and impact on sales, gains were
running at an even higher pace than last year. And
2011’s flows came despite a 90% drop in overall
flows into long-term UCITS during the same period.
There are now over 1,500 UCITS funds in Europe
• Regulators remain concerned with the growth of
derivatives use among regulated funds and have
been reviewing derivatives policy for more than a
year. The SEC has gone so far as to freeze most
approvals of new funds and ETFs that rely heavily
on derivatives, as it continues to conduct its review.
• Investors and their advisors can be intimidated by
these often-complex products. Active outreach and
marketing campaigns are common among the retailoriented
firms that dominate the space.
• Assets in the regulated alternatives space tend to
migrate to the largest professionally managed funds
with the strongest performance. While performance
matters for funds with track records, new unrated
funds also get a large share of sales.
• The future of alternative investments through
regulated funds hinges to a large degree on robust
risk management. Fund managers assume primary
responsibility for implementing the necessary
controls, but independent service providers also play
important roles. Investors can also take some comfort
in detailed regulatory requirements around risk
measurement and management, liquidity,
counterparty diversification, and limits on leverage.
2

• Europe and the U.S. have been at the forefront of product innovation, but
alternative strategies in regulated retail fund form are now appearing in
other parts of the world. Opportunities for alternative managers are growing
across Asia, Latin America, and the Middle East, driven by demand from both
private investors and institutions.
• Despite becoming increasingly competitive, the market for regulated alternative
funds remains much more fragmented than traditional parts of the business, and
no dominant players have yet emerged. As managers jockey for position and vie for
the attention of investors, intermediaries, and gatekeepers, product innovation and
distribution expertise will be key factors in determining the winners.
• Partnerships that combine the investment expertise of existing alternative
managers with the distribution prowess of traditional managers will become more
common as managers of all stripes look for ways to gain a foothold in one of the
most dynamic and growing parts of the asset management business.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
“ With no slowdown of demand in sight,
assets in alternative mutual funds and
UCITS could hit the $1 trillion mark
by 2014.”
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REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
The Convergence Factor
Three major global financial market crises in a ten-year investment approaches. Retail investors and their
span have dramatically transformed investor attitudes. advisors now are gravitating towards the greater diversity
As a result, asset managers and advisors are grappling (and complexity) of alternative strategies that before
with how to adapt to this new era. Their responses, along were pursued mainly by institutional and high net worth
with those of regulators and distributors, are redefining individuals. Institutions, meanwhile, continue to seek
investment product structures.
diversification through alternatives, but increasingly
appreciate the transparency, liquidity, and regulatory
A key facet of this evolution is the convergence of
controls found within regulated pooled products,
strategies previously segregated along retail versus
previously associated primarily with retail investors.
institutional lines as well as traditional versus alternative
Another Year of Robust Inflows
Convergence can be seen in the significant levels of
capital that continue to migrate into alternative
investment strategies found within regulated UCITS
funds and U.S.-registered mutual funds. There is no
universally agreed-upon definition of “alternative”, but
it can be applied to virtually any strategy that ventures
beyond long-only investing in equities and debt
instruments. This definition includes funds using hedge
fund-like strategies or tactical allocation, and ranges to
funds investing in commodities and currencies. During
the first eight months of 2011, investors around the
world put more than $61 billion into regulated funds
using alternative strategies. This comes after $116
billion of inflows into such funds during all of 2010.
Figure 1: Net Flows into Alternative UCITS and Mutual Funds/ETFs
20
U.S. $Billions
10
0
-10
-20
Alternative UCITS Funds
U.S. Alternative Mutual Funds/ETFs
-30
Jan'07 Dec'07 Nov'08 Oct'09 Sept'10 Aug'11
Source: SEI Knowledge Partnership; Strategic Insight Simfund GL, MF
Source: Strategic Insight Simfund GL, MF
The industry is thus on track for 2011 to be another big
year of flows into regulated funds with alternative
strategies, with no slowdown of demand on the horizon.
Indeed, assets in alternative mutual funds and UCITS
could hit the $1 trillion mark in 2014—and double
today’s $644 billion in 2016.
As investors face an uncertain and more volatile
economic future, they are recognizing the value that
strategies around absolute and/or uncorrelated returns
could provide as a way to help bolster portfolio
performance, protect capital, and lower volatility.
Meanwhile, traditional managers are launching long/
short, absolute return, and other alternative funds
to tap higher-fee growth areas, while alternative
managers are launching regulated retail funds
to expand and diversify their client base.
Alternative strategies are the most popular category in
asset managers’ product development pipelines with
4

managers such as Altegris, BlackRock, PIMCO, Nuveen, Alternative investment strategies within both UCITS
and First Eagle filing with the U.S. SEC to offer mutual funds and ‘40 Act mutual funds continue to grow even
funds that rely on managed futures, long/short, credit, as the overall asset management industry faces more
commodities, arbitrage, absolute return fixed income difficult business conditions. At the end of August 2011,
and other alternative strategies. Even investment
alternative strategies in UCITS and U.S. mutual funds/
management firms without “alternative” fund offerings ETFs managed a combined $644 billion in assets, up
are being affected, as they must navigate a marketplace 134% from the $275 billion at the end of 2006.
that is being redrawn by the growth of such products.
Figure 2: Assets in Alternative UCITS and Mutual Funds/ETFs
700
U.S Alternative Mutual Funds/ETFs Alternative UCITS Funds
600
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
500
U.S. $Billions
400
300
200
100
0
Jan'07 Dec'07 Nov'08 Oct'09 Sept'10 Aug'11
Source: SEI Knowledge Partnership, Strategic Insight Simfund GL, MF
Source: SEI Knowledge Partnership, Strategic Insight Simfund GL, MF
What’s more, alternative strategies, although still a small
portion of the UCITS and U.S. mutual fund markets,
have continued to increase their market share. At the
end of August 2011, alternative strategy funds’ AUM
were 4.4% of “traditional” UCITS and U.S. funds’ AUM,
up from 2.2% at the start of 2007. This is due to the fact
that assets in traditional UCITS and U.S. funds have
been growing at 3.6% per year since 2006, while assets
in alternative strategy UCITS and U.S. mutual funds
have been growing at 17% per year during that time.
As Figure 3 shows, annual growth for alternative UCITS
and U.S. funds handily outpaced the total industry’s
growth in five of the past six years, and is on pace to
do again this year.
Figure 3: Asset Growth Rates: Alternative vs. Total UCITS & Mutual Fund Industry
100%
80%
Total UCITS & U.S. Fund Industry
Alternative UCITS & U.S. Funds
Annual Asset Growth Rate
60%
40%
20%
0%
-20%
-40%
2005 2006 2007 2008 2009 2010 2011E*
*Annualized
Source: Strategic Insight Simfund MF, GL *Annualized
Source: SEI Knowledge Partnership; Strategic Insight Simfund MF, GL
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REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
One Third of UCITS Flows Go to Alternatives
The remarkable progress of alternative strategies is Alternative UCITS funds have navigated this volatile
evident in the substantial share of total industry gains environment without any meaningful operational
they now capture, accounting for 39% of year-to-date or liquidity crises so far, a fact that is encouraging
flows to all long-term actively managed UCITS, a confidence. Growing familiarity with the strategies,
far higher proportion than many had anticipated. and acknowledgement by Europe’s fund industry that
Alternative strategies inside UCITS attracted $22 the use of sophisticated investment techniques or
billion of net new flows in the first eight months of derivatives do not necessarily imply higher risks 1 ,
2011. This was achieved despite overall flows into suggest more supportive views on the long-term role
long-term UCITS declining by over 90% during the of such products in the regulated retail world than
same period.
before. The industry and regulators alike nevertheless
remain attentive to the potential risks of alternative
Such gains are being facilitated by the emergence
strategies, and are constantly reviewing additional
of a few well-established alternative UCITS funds with
protective measures.
appealing track records, competitive returns, relatively
transparent investment and risk management
Efforts are underway in Europe to better identify
strategies, and strong brands. The biggest individual the distinct strategies and hedge fund styles being
product, Standard Life Global Absolute Return
implemented in UCITS. One example is the recent
Strategies, now has $13.6 billion in assets and is the introduction of more precise classifications by
15th-largest long-term fund in Europe. In addition, independent fund information providers, a significant
the top selling alternative UCITS new introduction improvement from the generic “absolute return”
thus far this year is a SICAV version of this fund groupings used previously, which further promotes
designed for cross-border distribution collecting over the professional selection, monitoring, and
$1.5 billion. During the same period, PIMCO GIS benchmarking of regulated alternative funds and
Unconstrained Bond, launched in December 2008, easier integration of them into investment portfolios.
successfully raised nearly $3 billion in flows making
it the best-selling alternative UCITS product to date
in 2011. The growth and visibility of such alternative
fund leaders are buoying faith among a broadening
base of investors.
“ The evolution of investment philosophies and
strategies is causing previously distinct investor
segments and products to converge. ”
6
1
See “The Evolving Investment Strategies of UCITS”, European Fund and Asset Management Association, May 2011.

New European Launches Broaden the Field
There are now over 1,500 UCITS funds in Europe using The most successful offering in 2011 is the Standard
alternative strategies and managing a combined $254 Life SICAV Global Absolute Return Strategies, which
billion of assets 2 . Moreover, many of them have
raised $1.5 billion in the eight months following its
achieved a meaningful size, with 41 funds managing in launch. Others include Deutsche Asset Management’s
excess of $1 billion and another 65 portfolios running DB Platinum IV dbX Systematic Alpha Index, which
between $500 million and $1 billion apiece.
captured $1.1 billion of net flows in the 12 months since
its launch and the Solo Absolute Bond & Currency Fund
The field is growing with new introductions and product
from Natixis, which pulled in $750 million in the three
range extensions. During the first eight months of 2011,
months since its launch. Together these and other funds
fund managers launched 170 new alternative UCITS,
confirm a more robust evolution of demand for new
collectively raising $10 billion from investors across
alternative products than predicted after the relatively
Europe and internationally.
lackluster UCITS experiments by hedge fund managers
New launches are also gathering greater assets than a year or two ago. See Figure 4.
before. The amount raised in the first half of 2011 is
a notable leap from the second half the previous year
when new funds raised just $4 billion.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Figure 4: Biggest Alternative UCITS and Mutual Funds
Morningstar Category
Launch Date
Net Flows
$B YTD Aug ‘11
Assets
$B Aug ‘11
Europe UCITS
Standard Life Invsmts Glo Absolute Return Strat Alt—Multistrategy 2008 2.7 13.6
Julius Baer BF Absolute Return-EUR B Alt—Long/Short Debt 2008 -0.6 7.8
Newton Real Return A GBP Fund GBP Flexible Allocation 1993 2.5 7.0
JP Morgan Income Opportunity A Acc EUR USD Flexible Bond 2007 2.1 7.0
PIMCO GIS Unconstrained Bond Institl USD Acc USD Flexible Bond 2011 2.9 6.4
U.S. Funds
SPDR Gold Shares Gold 2004 -2.4 71.8
PIMCO Commdty Real Return Strategy Commodities 2002 2.4 27.6
Ivy Asset Strategy World Allocation 1995 1.8 27.1
iShares Silver Trust Silver 2006 -1.2 13.0
iShares Gold Trust Gold 2005 2.5 9.7
Source: SEI Knowledge Partnership; Strategic Insight Simfund GL, MF
Though acceptance is spreading, many investors and
intermediaries remain in the early stages of incorporating
alternatives into their investment programs. This
suggests much room for growth if regulated alternative
funds continue to manage their risks, offer investors
the same level of fundamental protections as other
regulated products, and deliver reasonable results and
value over time. And managers of these funds must
help intermediaries and investors better understand
the strategies and how they fit in a portfolio.
2
Strategic Insight has been tracking alternative strategies in UCITS for over half a decade, and now combines its own research with classifications from Morningstar, Lipper, and other
specialist fund trackers who focus on the hedge fund style UCITS universe to determine the most relevant peer group of alternative investment funds.
7

REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Gains in the U.S. Despite Challenges
Alternative strategies through U.S. mutual funds and “microsites” devoted to particular alternative-strategy
ETFs drew $39 billion in net inflows in the first eight products complete with whitepapers and videos in
months of 2011, on pace to come near 2010’s $65 addition to fact sheets and regulatory filings. For
billion. The “alternative” category, which comprises example, in early 2011, seven asset managers,
multiple investment strategies and asset classes, is including Forward, JP Morgan and Eaton Vance,
heterogeneous enough that when precious metals funds teamed up for a three-city road show aimed at
in 2011 failed to continue the torrid sales of 2010, the explaining alternative-strategy mutual funds to
slack in alternative fund flows was picked up by other independent registered investment advisors (RIAs).
commodity funds and by alternative-style global tactical Still, these products can be hard to place in the huge
asset allocation (GTAA) funds, a fast-growing category and highly regulated arena of defined-contribution
whose funds may invest anywhere around the world in retirement plans, where plan sponsors tend to be
any asset class, akin to global macro hedge funds. By conservative; but alternative-strategy funds are slowly
the end of August, the U.S. had roughly 730 alternative gaining a toehold as sleeves within funds-of-funds in
mutual funds and ETFs, 118 of which had been
such plans.
launched in the first eight months alone.
In the retail-oriented U.S. market for alternative strategy
Despite their momentum, alternative mutual funds face mutual funds, managers’ marketing and sales efforts
several challenges. Like their colleagues across the often prioritize the independent RIAs, who tend to be
Atlantic, the SEC has been concerned about the
early adopters of alternative strategies and structures.
regulatory and disclosure implications of the growth of Broker-dealers, the most important distribution outlet for
derivatives use among mutual funds and has been mutual funds, also have a growing population of RIA-like
reviewing derivatives policy for more than a year. The advisors: those who use a rep-as-portfolio manager
agency has gone so far as to freeze most approvals platform. These advisors have full discretion over client
of new funds and ETFs that rely heavily on derivatives, assets and construct client portfolios rather than using
as it continues to conduct its review.
model portfolios provided by due diligence teams at their
firm’s headquarters. Advisors utilizing this fast-growing
Investors and their advisors can also be intimidated
model are decidedly heavier users of alternative mutual
by these often-complex products. Active outreach and
funds (especially GTAA) and ETFs. They also tend to
marketing campaigns are common among the retailoriented
firms that dominate the space. Money
hold funds and ETFs for shorter periods than other
advisors, so managers should recognize that there
managers such as Putnam Investments have web
is a trade-off for their early acceptance.
8

Performance with Other Factors Driving Sales
Similar to hedge funds and traditional long-only
less. As a group, these low-rated funds suffered net
managed funds, assets in the regulated alternatives redemptions, as Figure 5 illustrates 3 . We observed
space migrate to the largest professionally managed similar relationships between performance and flows
funds with the strongest performance. Sales results in practically all asset classes, markets, and time
closely correspond with an individual fund’s absolute periods over the past 20 years.
and relative results, and various measures of riskadjusted
returns.
While performance matters for funds with a track
record, new unrated funds also get a large share of
For example, among alternative UCITS with a track sales. This is especially true in the alternatives segment
record, 69% of YTD 2011 flows went to funds with where many funds do not yet have long track records,
Morningstar’s top 5-star risk-adjusted return rating, but where the manager might have a reputation running
and another 28% of flows to products with a high similar strategies in another format. Views that newer,
4-star rating—even though only a third of rated funds smaller funds could exercise greater flexibility and
earned these star ratings. Most have three stars or potentially outperform larger funds may also play a role.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Figure 5: Alternative UCITS Flows YTD Aug ’11 By Morningstar Rating*
6.0
5.0
4.0
U.S. $Billions
3.0
2.0
1.0
0
-1.0
5 4 3 2 1
Morningstar Rating
* Data reflects only funds with Morningstar ratings. Data does not include
all alternative UCITS funds, in particular new funds without a rating.
Source: SEI Knowledge Partnership; Strategic Insight Simfund GL
3
Based on Strategic Insight’s analysis through August 2011 of its own calculated flows within SI’s Simfund Global database, for the entire SI universe of alternatives, using Morningstar Ratings.
9

REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Figure 6: Alternative and Traditional UCITS Fund Asset-Weighted Performance
110
105
100
95
90
85
80
Alternative Strategies
Traditional Long-Term Assets
75
Dec ’06 Jun ’07 Dec ’07 Jun ’08 Dec ’08 Jun ’09 Dec ’09 Jun ’10 Dec ’10 Jun ’11
Source: Strategic Insight asset-weighted calculations in Euro terms based on returns from Morningstar Inc and Lipper Inc Returns represent
asset-weighted composites of Euro-base primary share classes only; traditional long-term assets excludes money markets and alternatives
Source: SEI Knowledge Partnership; Strategic Insight asset-weighted calculations in Euro terms based on returns from Morningstar Inc and Lipper Inc
Returns represent asset-weighted composites of Euro-based primary share classes only; traditional long-term assets exclude money markets and alternatives.
More importantly, in Figure 6, the success of alternative
UCITS coincides with returns that have matched
traditional assets—with lower volatility—over the past half
decade. From the viewpoint of a Europe-based investor,
regulated alternative strategies lost only 7% during the
year of the 2008 financial crisis, while traditional funds
(equity, bond, balanced, and other long-term asset
classes) suffered a 21% average loss on an assetweighted
basis 4 . Though traditional assets delivered
higher returns during the 2009 and 2010 calendar years,
alternative UCITS achieved similar cumulative returns
since the start of 2007, with lower volatility.
Results appear even better for UK-based investors.
Alternative UCITS in the UK returned 13% on an
average asset-weighted basis in 2009 and 8% in 2010 in
GBP terms which, along with these funds’ other
attributes, proved appealing to local institutional
investors and retail investors through IFAs.
Comparing the performance of alternative UCITS versus
unregulated offshore hedge funds is difficult, since most
hedge funds and indexes are managed and reported
on a U.S. Dollar basis, while alternative UCITS are better
understood in Euro terms from the vantage point of
European investors. In any case, most sophisticated
investors do not necessarily expect results from
regulated alternative vehicles to match or exceed
unregulated leveraged hedge funds. Most instead weigh
the potential performance tradeoff against the benefits
of a regulated, transparent, and liquid vehicle, using
recent years’ track records as a guide.
Similarly, performance comparisons between U.S.
alternative mutual funds and U.S. hedge funds are
difficult, in part because the vast majority of the
alternative mutual funds are—unlike in Europe—
managed by traditional fund managers and are therefore
not versions of existing hedge funds. The promise of
alternative mutual funds in the U.S. has flipped in recent
years. Prior to the financial crisis, the sale of alternative
strategies relied heavily on the possibility of boosting
alpha (potentially a risk enhancer). Since the crisis,
alternative mutual funds have been positioned more
as a means to reduce volatility and provide downside
protection (potentially a risk reducer). This has been a
particularly important feature given the tumultuous rise
and fall of the equity markets—together with the low
or no return fixed income market—throughout 2011.
10
4
Asset-weighted average returns provide a better proxy of the experience of most investors, and thereby helps explain investor choices.

The Role of Risk Management
The future of alternative investments through regulated ESMA, this summer, issued a consultation on the risks of
funds, whether UCITS, ’40 Act mutual funds, or similar synthetic ETFs and structured UCITS, with implications
structures around the world, will depend to a large for alternative strategies relying on derivatives. Among the
degree on robust management of the many complex issues emerging from the process are proposals for
risks of such strategies. The responsibility rests primarily separating UCITS into non-complex versus complex
on the fund managers to implement the necessary products. In October, the European Commission’s review
internal controls, but with the help of independent of the Markets in Financial Instruments Directive (MiFID
service providers and with effective oversight by
II) supported the distinction of structured UCITS as
regulators and industry peer review.
complex instruments, which would place certain
restrictions on their availability to retail investors.
The regulatory frameworks of both UCITS and U.S.
mutual funds provided a strong foundation for risk The regulation and distribution of hedge fund-style
management and investor protection. Investors seeking alternative UCITS will remain closely intertwined with
alternative investment strategies following the 2008 evolving policy orientations on synthetic ETFs. The use
financial crisis have found comfort in the detailed of derivatives and swaps in ETFs, a segment where
requirements around risk measurement and
synthetic products account for 65% of the European
management, liquidity, counterparty diversification, and industry, is an increasingly visible issue that has led
limits on leverage, while leaving sufficient flexibility to regulators other than ESMA to examine their
implement a diverse range of strategies.
counterparty, liquidity, and systemic risks 5 . The
spotlight on these risks has contributed to a shift in
Yet the expanding use of derivatives and their associated
European ETF flows in 2011, with more capital flowing
counterparty and operational risks continues to concern
to “physical” ETFs in recent months than to swapsbased
“synthetic” ETFs. Clearly, industry players have
investors and regulators alike. Regulators and industry
associations are exploring additional measures to improve
strong incentives to buttress confidence in derivatives
internal controls and strengthen oversight. Last year, the
use, and we believe the focus on this issue will help the
Committee of European Securities Regulators (CESR)
industry in the long run.
provided guidance on risk management including
counterparty risks. CESR has since been replaced by the
European Securities and Markets Authority (ESMA), an
independent EU authority that continues to actively
assess these issues.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
“ The future will depend on robust management of the
many complex risks of alternative strategies.”
5
See “Market Structures and Systemic Risks of Exchange-Traded Funds” from the BIS, April 2011.
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REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
AIFMD Opens New Doors
Earlier uncertainties around changing hedge fund
regulations, particularly fears that the Alternative
Investment Fund Managers Directive (AIFMD or
Directive) might create hardships for certain non-EU
funds to conduct business in Europe, had prompted
hedge fund managers to consider or launch alternative
strategies within UCITS which sit outside the scope
of the Directive.
Questions still remain, but the final draft of the
regulations as published in July 2011 is causing less
worry for hedge fund managers than first feared.
This is helping to dissipate the attention of hedge fund
managers on UCITS as a way to get around the
limitations of AIFMD. The positive development allows
both alternative and traditional managers to consider
various different vehicles—both offshore and onshore
hedge structures as well as UCITS where appropriate—
and choose the most suitable for their investment
strategy and target clientele.
Luxembourg and Ireland are adapting their respective
laws on Specialized Investment Funds (SIFs) and
Qualifying Investor Funds (QIFs)—both regulated
product structures—to align with AIFMD, and to
establish these vehicles as a suitable structure for
hedge fund providers. These and other EU-domiciled
alternative investment funds (AIFs) offer transparency,
liquidity and access to Europe’s investors while
providing greater flexibility than UCITS, possibly making
them preferable structures for certain hedge fund
strategies and investor types. SIFs and QIFs are thus
expected to grow in the coming years as AIFMD settles
into place. Assets in Irish QIFs expanded 35% in 2010
to end the year at $209 billion, while Luxembourg SIFs
grew 39% to reach $292 billion. This suggests that
investors put in about $102 billion combined of net
new money into QIFs and SIFs.
Despite the expected growth of AIFs as AIFMD takes
effect, many hedge fund and mainstream asset
managers will undoubtedly continue to recognize
UCITS as an appropriate structure for many highly
liquid and unleveraged alternative strategies. Wellmanaged
alternative UCITS with the right distribution
approach have proven that they can consistently attract
a very high level of assets. Moreover, their popularity
continues to grow among institutional and individual
investors as well as fund selectors and advisors, as they
seek less correlated investments, additional sources
of capital appreciation and income potential.
12

New Frontiers
Europe and the U.S. have been at the forefront of
product innovation, but alternative strategies in
regulated retail fund form are now appearing in other
parts of the world. Notably, the $2 billion launch in the
2nd quarter 2011 of Nomura Global Trend in Japan,
a fund based on Man AHL’s managed futures strategy,
signals an important milestone in the spread of
alternative strategies to the Asia region. The fund’s
size would have been impressive under normal
circumstances, but is all the more noteworthy given
that fundraising occurred just after the country’s tragic
earthquake and tsunami.
The success of this fund will encourage additional
launches of regulated alternative investment funds
in Japan beyond the historic route
of structured products and private
placements. The mutual fund market
in Japan is the single greatest source
of new assets, with multi-billiondollar
mutual funds introduced on
a monthly basis. Thus, hedge fund
and other alternative managers may
increasingly consider building
relationships in that market.
Alternative strategies may benefit through adaptation
to the needs of investors in new markets, to incorporate
themes and features they find important. For instance,
Nomura Global Trend was offered in three currency
classes: (1) yen, (2) a basket of currencies driven by
natural resources—Brazilian real, Australian dollar,
and South African rand, and (3) a basket of Asian
currencies. The natural resource currency class
captured more than half of assets.
Opportunities for alternative managers are growing
across Asia, Latin America, and the Middle East, driven
by demand from both private investors and institutions.
In particular, sovereign wealth funds and national
pension funds, many of them collecting new assets on
a sustained basis, are considering greater
alternative investments to put those
assets to work and to diversify their
traditional strategic mix. Alternative
managers are also expecting wealthy
investors across Asia to consider
alternatives more seriously now,
following negative experiences over
many years with other asset classes.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
13

REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
Looking to the Future
Growth in the global retail market by alternative UCITS
and mutual funds will be spurred mostly by smaller
institutional investors. In the U.S., a greater number of
financial advisors are adding alternative funds to retail
portfolios as risk and volatility management become
higher priorities in advisor-client discussions. In Europe,
retail and institutional investors alike are gradually
migrating toward UCITS, attracted by the fact that they
are relatively liquid, transparent, and regulated.
However, it would be a mistake to view UCITS and ’40
Act funds as some sort of panacea. They work well as
vehicles for some investment strategies, but illiquidity
factors prevent them from working for other strategies.
They are ultimately just one more way for managers
to expand their investor base.
Despite this caveat, assets in alternative-strategy UCITS
and U.S. mutual funds should top $1 trillion in 2014,
assuming only modest performance gains over the next
few years, and barring a dramatic bear market. By 2016,
assets in such funds should more than double the
current $644 billion. Absolute return, hedge fund-like
strategies, and global tactical allocation funds are likely
to be major drivers of this growth. Commodity funds may
also grow as portfolio diversifiers, but demand is less
certain as they often mirror erratic commodity price
movements. Geographically, any slowdown in growth in
the U.S. and Europe will likely be partly offset by growth
in Asia and other newer regions.
Figure 7: Projected Growth of Alternative UCITS and Alternative U.S. Mutual Funds
1,500
1,250
U.S. $Billions
750
600
500
250
0
2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E 2016E
Source: Strategic Insight
Source: SEI Knowledge Partnership; Strategic Insight
14

Conclusion
A market of $1 trillion or more, and growing at such
a robust pace, means opportunities lie ahead for both
retail and institutional managers interested in alternative
strategies. With the development of regulated non-UCITS
funds such as QIFs and SIFs as vehicles for alternatives,
the market is even more substantial.
As managers jockey for position and vie for the attention
of investors, intermediaries, and gatekeepers, product
innovation and distribution expertise will be key factors
in determining the winners. And as the market matures,
assets will ultimately coalesce around managers that are
able to effectively combine both of these attributes with
a sterling reputation, an institutional quality process,
and proven performance.
Traditional fund managers should be able to leverage
their existing relationships with distributors as they roll
out alternative funds. Those with experience in educating
investors and advisors are likely to have an additional
advantage that will enable them to secure additional
market and mind share. Hedge fund managers wishing
to enter the market for regulated alternative funds may
prefer to find a retail-oriented manager with whom to
partner or enter into a subadvisory relationship. Such
partnerships, combining the investment expertise of one
firm with the distribution prowess of another, will almost
certainly become more common as managers of all
stripes look for ways to gain a foothold in one of the
most dynamic and growing parts of the asset
management business.
REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
“As managers jockey for position and vie for
the attention of investors, intermediaries, and
gatekeepers, product innovation and distribution
expertise will be key factors in determining
the winners.”
15

REGULATED ALTERNATIVE FUNDS: THE NEW CONVENTIONAL
About SEI
SEI (NASDAQ:SEIC) is a leading global provider of investment processing, fund processing, and investment
management business outsourcing solutions that help corporations, financial institutions, financial advisors, and
ultra-high-net-worth families create and manage wealth. As of September 30, 2011, through its subsidiaries and
partnerships in which the company has a significant interest, SEI manages or administers $395 billion in mutual
fund and pooled assets or separately managed assets, including $162 billion in assets under management and
$233 billion in client assets under administration. For more information, visit www.seic.com.
SEI’s Investment Manager Services division provides comprehensive operational outsourcing solutions to support
investment managers globally across a range of registered and unregistered fund structures, diverse investment
strategies and jurisdictions. With expertise covering traditional and alternative investment vehicles, the division
applies customized operating services, industry-leading technologies, and practical business and regulatory insights
to each client’s business objectives. SEI’s resources enable clients to meet the demands of the marketplace and
sharpen business strategies by focusing on their core competencies. The division has been recently recognized
by HFMWeek as “Most Innovative Fund Administrator (Over $30bn AUA)” and “Best Funds of Hedge Funds
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Provider of the Year” by the Money Management Institute, among other industry awards.
The SEI Knowledge Partnership is an ongoing source of action-oriented business intelligence and guidance for SEI’s
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of SEI’s Investment Manager Services division.
About Strategic Insight
Begun in 1986, Strategic Insight is a competitive intelligence source for the investment management industry,
providing clients with in-depth studies, consultation, and electronic decision support systems. SI assists over
250 organizations worldwide, including the largest mutual fund management companies operating in the U.S. and
the largest insurance companies serving the VA business. SI clients are responsible for about 90% of all U.S.
mutual fund assets. Strategic Insight also helps over 60 of the world’s largest asset managers expand in Europe and
Asia. Simfund, SI’s proprietary databases of mutual fund, ETF and VA information, are the most comprehensive in
the industry and integrate data on historical assets, net flows, performance information, fees and expenses, and
many more metrics. Strategic Insight has offices in New York, Boston, London, Hong Kong, and Melbourne.
For more information, visit our home at www.sionline.com. SI’s parent, Asset International, is an information
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16

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