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As registered funds increase in popularity, it’s important that financial advisors apply the same level of due diligence that they would for a private market investment.

Registered funds have helped to democratize hedging strategies and private market investments, allowing advisors and investors to access asset classes such as private equity, private credit, real assets, and certain hedge fund strategies. These investment types are valuable tools in achieving clients’ long-term goals and objectives.

Registered funds are subject to the Securities Act of 1940 and its investor protection provisions. These include enhanced governance and direct SEC (Securities and Exchange Commission) oversight and the requirement that each fund have an independent board of directors to manage potential conflicts of interest between managers and investors. Registered fund sponsors must also develop and adhere to a code of ethics; maintain policies and enforcement of insider trading rules; disclose any changes to investment strategy; report holdings on a regular basis; obtain prior consent of shareholders to change advisory contracts; and comply with other regulatory obligations.

While registered funds that invest in hedging strategies and private market investments provide certain protections, they may not be suitable for all investors. It is important for advisors to conduct due diligence on registered funds, much like the diligence of private investment structures. Due diligence should focus on gaining a clear sense of a fund’s investment objectives and risks, management, fees, and redemption options.

Assessing a fund’s investment objectives and risks

When considering an allocation to a registered fund, the most critical factors to review are a fund’s investment objectives and its expected risk and return profile. It is important to dig into the details here to ensure that you are setting appropriate client expectations for how a fund will perform.

There are several questions to ask to get a good sense of risk and return expectations:

  • What is a fund’s long-term investment objective?
  • Is it focused on income, growth, or a combination of the two?
  • What strategies will the manager use to meet the objective?
  • How does the manager expect the fund to perform in various market environments?
  • What is the manager’s current market outlook, and does the manager expect the fund to perform well given that viewpoint?
  • What are the primary risks that this fund is exposed to, and how are they managed within the fund?

Once you feel comfortable that you understand the risk and return profile of a registered fund, you can determine if it aligns with a client’s investment objectives.

Evaluating manager track record and fund fees

While evaluating the risk and return profile, you will get a sense of how a manager views the markets and how they apply their skills to manage the fund. Registered funds that incorporate hedging or private investment strategies could potentially have minimal, if any, track records, so it is important to investigate the manager’s background and previous investment experience running a similar strategy or their past performance with other fund companies.

Fees are another key area of due diligence. Most registered funds will have three distinct types of fees: up-front or offering fees; operating fees; and liquidation fees. Up-front fees include commissions and marketing fees. Examples of operating fees include real estate property management fees, financing fees, or performance-based fees based on achieving pre-specified metrics. Liquidity fees include real estate disposition fees, loan termination fees, or other fees and expenses related to selling or liquidating fund assets. Fees can vary significantly by structure and asset type, so an important factor in reviewing fees is to compare similar funds.

Liquidity and redemption considerations

Another key area to review as part of the due diligence of a registered fund is its liquidity or redemption options. An example of key questions to ask include:

  • What, if any, redemption options does the fund provide?
  • At what frequency are redemptions offered, and what is the maximum amount of fund assets that can be redeemed in a given time period?
  • If a fund allows periodic redemptions and provides a certain amount of liquidity, how do they manage their cash?
  • What percentage of fund assets are needed to maintain liquidity, and what percentage has the fund held historically?
  • How does the manager balance liquidity while limiting the impact on returns of holding cash?

Growth in the registered fund market has given accredited and retail investors access to once inaccessible hedging and private investment strategies. However, it is critical that advisors perform proper due diligence of a fund’s investment objectives and risks, performance expectations, management, fees, and redemption options. A full understanding of these characteristics will help you to properly position these funds in portfolios, so that your clients stay invested for the long term.

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IMPORTANT INFORMATION

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by Institutional Capital Network, Inc. or its affiliates (together “iCapital Network”). Past performance is not indicative of future results. Alternative investments are complex, speculative investment vehicles and are not suitable for all investors. An investment in an alternative investment entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. The information contained herein is subject to change and is also incomplete. This industry information and its importance is an opinion only and should not be relied upon as the only important information available. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed, and iCapital Network assumes no liability for the information provided.

Products offered by iCapital Network are typically private placements that are sold only to qualified clients of iCapital Network through transactions that are exempt from registration under the Securities Act of 1933 pursuant to Rule 506(b) of Regulation D promulgated thereunder (“Private Placements”). An investment in any product issued pursuant to a Private Placement, such as the funds described, entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. Further, such investments are not subject to the same levels of regulatory scrutiny as publicly listed investments, and as a result, investors may have access to significantly less information than they can access with respect to publicly listed investments. Prospective investors should also note that investments in the products described involve long lock-ups and do not provide investors with liquidity.

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Laura Sexton

Laura Sexton

Laura is an Assistant VP on the Research & Diligence team at iCapital Network, where she focuses on fund research and due diligence. Prior to joining the firm, Laura was a Senior Director of Program Management at AI Insight and led a team that was responsible for alternative investment industry and fund data on the AI Insight platform. Previously, she was a Director for Snyder Kearney and SK Research with responsibilities for both research and due diligence of public and private real estate programs. She also held roles at LPL Financial and Lincoln Financial Partners. Laura received a BA in Education from Purdue University.