Flight from alt funds could attract regulators’ attention

Certain alternative investment funds are facing elevated redemption demands from retail investors — a development that poses possible regulatory and reputational risks to alt fund managers, if not an operational challenge, says Fitch Ratings.

In a new report, the rating agency said certain alt investment vehicles known as “perpetual non-traded” funds (typically REITs or business development corporations) have faced increased redemption requests from investors in recent months.

These vehicles, which aren’t publicly traded and so have no public liquidity, cap redemptions to preserve assets and fund managers’ fee revenues. Typically, funds cap redemptions at 2% of their net asset value per month, or 5% per quarter, it noted.

Recently, several funds have invoked their redemption limits after increased demands from investors hit their pre-determined thresholds, Fitch reported.

While these vehicles are performing as intended by enforcing their redemption limits, this also carries some reputational risk, it noted.

Additionally, continued high redemptions could cause these funds to either sell portfolio assets or increase borrowing to provide liquidity to investors — measures that could negatively impact asset values, fund performance and/or their leverage positions.

“Prolonged fund redemptions resulting in net outflows would negatively affect alt investment managers’ management fees,” Fitch said.

Allowing funds to exceed their pre-set redemption limits would “set a negative precedent,” Fitch said, by signalling that the fund managers will backstop these kinds of funds, and potentially other sorts of funds.

Additionally, the elevated redemption activity could attract regulators’ attention, it noted.

“Concerns over the illiquidity of funds may further negatively affect fund flows and raise scrutiny around product suitability for retail investors,” Fitch said. “There are no current regulatory proposals restricting these products, but recent headlines could put these and similarly structured products in focus.”

Despite these risks, the report said the increased redemptions should have a limited financial impact on the affected fund managers, and that the “scale and breadth of alt [managers’] overall platforms further mitigates potential pressure on management fees.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.