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Alternative Mutual Funds Under SEC Scrutiny

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The U.S. Securities and Exchange Commission (SEC.TO) came up with the regulatory examination of alternative mutual funds. These mutual funds, proposed to be more risky than standard ones, have raised concerns regarding their compliance with leverage and liquidity rules.

Alternative funds, also known as liquid alternative funds, are types of mutual funds that resemble hedge-fund-like strategies. Such strategies include betting on some stocks and against others, trading futures contracts and utilizing derivatives to augment leverage.

Alternative funds, which gained popularity over a short period, have been recommended by fund companies as the hedging tools against market risk for small investors at a lower cost. According to fund research firm Morningstar Inc., these funds recorded inflows of $40.2 billion in 2013, up from $14.5 billion in 2012.

The SEC strategizes to test around 25 of the funds over the next several months. The results of the test will determine the process of operating these mutual funds and the underlying degree of risk. Depending on the outcome, the SEC may decide if more fund companies need to be examined.

Some large investment firms, including BlackRock Inc. (BLK) and AQR Capital Management LLC, have come under the purview of scrutiny along with certain smaller firms, which initiated issuing such funds.

Some firms, which are on the verge of launching such funds for the first time or have already initiated, include The Goldman Sachs Group, Inc. (GS),  The Blackstone Group L.P. (BX), The Bank of New York Mellon Corp. (BK)  and Pacific Investment Management Co.

Following the surge of investments in alternative mutual funds, the SEC is examining the liquidity of these funds and the system followed by the funds’ boards in executing these funds’ operations. Moreover, along with funds’ managers, mutual fund board members are also being questioned.

As per the Investment Company Act of 1940, the SEC regulates mutual funds to safeguard investors. The scrutiny is currently seeking information about the industry and not enforcing any actions. However, the outcome of the examination would give a clear picture for both funds’ managers and investors and help SEC and other regulators decide on the next corrective action.

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