Global Custodian Interview: Larch Lane on Launching a Liquid Alternative Fund

Liquid alternatives continue their rise in popularity, as two more hedge fund firms, Larch Lane and Rothschild Asset Management, have entered this space. The two firms partnered to act as a joint advisor to the Rothschild Larch Lane Alternatives Fund, which began publicly trading in July. Larch Lane’s David Katz, president and chief operating officer, and Eric Konigsberg, director of risk management, explain the decision behind entering the ‘40 Act world and what these vehicles require from service providers.

GC: How did you choose to launch this type of fund?

David Katz: Over the last several years, we noticed a significant amount of demand by retail investors for liquid alternatives. Following the post-2008 financial crisis, we began to witness a desire for access to alternatives in regulated liquid structures. Ultimately we decided to meet that demand and launch a registered mutual fund which would provide access to hedge fund strategies that were not previously available to the retail market.

GC: What do you have to do to enhance the reach to this new client base? Is there a sense that some view it as riskier than it might actually be?

DK: First, I should explain the history of why we partnered with Rothschild Asset Management. An important element is that we, like them, have a 20-year history of managing hedge fund portfolios. Larch Lane and Rothschild also bring complementary research capabilities to the joint venture. We both were thinking about the demand in the same way.

Accessing the retail market can be different than accessing the institutional market. Having a sizable distribution effort is critical. The distribution plan is extremely important. And as part of our relationship, Rothschild has that effort in place, in the U.S. and globally.

In terms of risks, part of that is allayed for investors in two ways: one is that activity is regulated by the ‘40 Act—there are a significant amount of restrictions, which are regulated and monitored carefully. The second is that these mutual funds are liquid, so an investor can buy and sell on a daily basis, unlike in the private world where there are different liquidity constraints in place.

GC: Is there any concern that by launching this type of vehicle that you’d then get institutional investors interested because of the lower fees and that they would invest in it rather than a private fund? Is there any sense that it could be cannibalistic?

DK: I don’t think we’re concerned about that. We think institutions will also utilize alternatives mutual funds, because they are regulated, they are liquid, the fees are cheaper than traditional hedge funds, and they offer necessary diversification benefits to institutional investors.

Another area where we think retail investors will embrace these liquid alternatives mutual funds is in the defined contribution (DC) space. Today, there are a limited number of plan sponsors that offer daily, liquid alternative mutual funds, but we think that this will change. Defined benefit (DB) plans access the alternatives market through hedge funds, and we believe that DC plans will do the same. Plan sponsors will eventually begin adding these kinds of funds to their 401(k) lineups, or they’ll do it through their target-date fund allocations. The potential flow of assets into the DC market is huge.

GC: Is getting into DC plans something that’s in the pipeline already?

DK: Yes, it’s in the pipeline already, although we do think it’s a bit further out. Many of the players in this space are hoping that DC plans will begin to offer these. Many plan sponsors believe that participants in a 401(k) plan should also be able to access these diversified strategies.

GC: Would you launch another liquid alternative fund, or are you focused on just growing the assets of your existing fund?

DK: We’re always thinking about what the market wants and always innovating. If there’s another product different than what we created, and we think the opportunity set is large enough, we would certainly consider doing that.

GC: Does launching a liquid alternative fund require a different process for selecting service providers compared to what you do for a private fund?

DK: It’s similar. We’ve always taken very seriously the quality and appropriateness of the different service providers that we use or any of the hedge funds in which we invest use. We do a lot of due diligence on those entities. But there are certain complexities associated with investing in a ‘40 Act fund that are different from a private fund, so it requires us to have an additional set of criteria for service providers that we use. So yes, the way we look at service providers requires the same level of due diligence, but there’s an additional requirement because in the ‘40 Act world, we have to ensure that we’re compliant with some of those restrictions in ways that we are not in the private world.

GC: What led to selecting TS Imagine?

EK: We’ve always recognized TS Imagine as one of the pioneer risk vendors in the alternatives investment space. When we started talking about launching a ‘40 Act Fund, we needed a way to monitor regulatory and risk limits. We evaluated a number of different vendors, and when talking to TS Imagine, we realized that we had a common view—that there is a need for a system that monitors both regulatory and investment risk guidelines. To my belief that doesn’t really exist anywhere else.

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