Next stage of evolution in the ’40 Act marketplace

Servicing approximately 113 liquid alternative funds that operate under the '40 Act banner, U.S. Bancorp Fund Services (`UBSFS') is ideally positioned to understand the complexities of administration and compliance involved in with these vehicles. USBFS opened its doors in 1969 and since that time, the firm has been servicing these funds for over 20 years; although, back in the 1990s the term "liquid alternative" didn't exist. 

Still, with 878 funds and more than USD347 billion in assets (though Q1 2015, according to Morningstar), liquid alternatives represent an important growth driver for USBFS.

"Liquid alternatives revenue for us has ranged from 13 to 24 per cent in the last couple of years with respect to our overall '40 Act new business. We're dedicated to servicing funds in this space and building new relationships," comments Bob Kern (pictured), Executive Vice President at U.S. Bancorp Fund Services. 

Whilst the relative performance of liquid alternatives compared to hedge funds is reasonable, "the asset class loses lustre as it has underperformed the broader market on an absolute basis," says Joe Redwine, CEO, U.S. Bancorp Fund Services. "We may very well be entering a period where traditional markets will come under greater stress, and when that inevitability occurs, the absolute performance of liquid alternatives will start to look more positive."

In a recent presentation at the Brookings Institution in Washington DC, SEC Commissioner Kara M Stein said that the liquid alternatives trend "should give everyone pause, and regulators and the public need to be asking questions about this development". 

Redwine believes this is an appropriate comment and that the biggest challenge is one of education: "Education of all associated with or overseeing liquid alternative funds – the regulators, distribution channels, and the investors. That education process is taking place but needs to ratchet up significantly."

At USBFS, much time and focus is placed on educating advisors that have historically only ever operated in the unregistered private fund market. All aspects of compliance are covered, both with advisors and their investment boards. 

"Hedge fund managers entering the '40 Act space don't necessarily understand all the rules and regulations, the onboarding and launch process, the compliance costs of running a '40 Act fund, etc. We bring them up to speed in all these areas," explains Kern. 

"Furthermore, traditional fund houses who decide to launch a multi-manager liquid alternative also need support. The complexities and compliance issues apply not just at the fund level, but also at the asset level; especially with respect to more esoteric asset classes such as bank loans and derivative-based strategies, where the oversight and compliance demands ramp up quite significantly."

Indeed, the more illiquid end of the spectrum is proving popular. Known as "interval funds", they allow alternative fund managers to more closely mimic private fund strategies and typically use a monthly subscription, quarterly redemption model. 

"Currently, we provide a full array of services to 18 interval funds. These include fund-of-funds, bank loan, peer-to-peer lending and CLO/CDO funds. One of the more interesting strategies is a fund that invests in reinsurance quota shares," confirms Redwine. 

This serves to illustrate how far the '40 Act fund market has come in 75 years.

"We're seeing more interval fund opportunities than ever before. At any point in time we've probably got half a dozen proposals outstanding," concludes Kern.

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