Conversations With… David Kupperman
A Fresh Take on ‘Liquid Alternatives’
Alternative mutual funds, commonly known as “liquid alternatives,” continue to gain attention from investors who are looking to diversify their portfolios with alternative investment strategies that also provide daily liquidity.
Such funds combine the benefits of a ’40 Act mutual fund structure with the potential for lower volatility and market sensitivity provided by alternative strategies. David Kupperman is a member of the investment team for the Neuberger Berman Absolute Return Multi-Manager Fund, launched in May 2012, which invests with an array of top hedge fund managers. David sat down with us recently to discuss the Fund and the appeal of alternative strategies.
How may the Fund help investors?
Right now, the average investor tends to own the traditional asset classes and doesn’t have access to more diversifying strategies. And although liquid alternatives are a great way to achieve diversification, it can be difficult to assemble them into a well-rounded portfolio—which takes specialized knowledge and a significant time commitment. We’ve used our expertise as a fund of hedge funds team to create a product that really simplifies this task. It brings together top hedge fund managers across strategies that aim to provide an independent source of return and reduced sensitivity to the broad markets.
What’s new about your offering?
We were the first firm with both hedge fund experience and infrastructure as a mutual fund company to put together this type of alternative multi-manager mutual fund. In doing so, I think we’ve taken the industry to the next level—in a number of ways. We’ve used our brand and our relationships to attract great hedge fund managers, negotiate more attractive fee arrangements, build a more robust operational infrastructure and achieve meaningful, independent risk oversight. These and other features really set us apart.
What are the benefits of the mutual fund structure?
Mutual funds have a lot of positives compared to the traditional hedge fund vehicles. From an implementation perspective, you can have much lower minimums, investors don’t have to be accredited, tax reporting is much simpler and you don’t need to execute a subscription agreement.
Also, there is much greater transparency and the fee structure is advantageous. From an investment perspective, managers can execute most investment strategies just as they would in a typical hedge fund structure. In our Fund, we include strategies such as long-short equity, event-driven, merger arbitrage, credit arbitrage, asset-backed securities, and are considering adding macro and managed futures strategies in the future.
A few years ago, funds like this didn’t exist. What’s changed?
There have been a couple of drivers. One is fee related. Hedge fund managers have historically charged both management and performance fees (typically 2% and 20%, respectively). But since 2008, it’s become harder for them to attract capital, as a few very large hedge funds have been getting most of the inflows. This has made the rest of the managers more open to negotiating on both terms and structure. So in our Fund, for example, the managers get a management fee that is typically lower than the fees they may have charged historically and do not get a performance fee. Another issue is knowledge. Many hedge fund managers simply assumed that they could not execute their strategies in a mutual fund vehicle. However, they’ve come to understand that they can.
There’s also a clearer sense of the untapped demand for multi-manager liquid alternative funds, not only from individuals who previously couldn’t access hedge fund strategies, but also from defined contribution plans that are beginning to recognize the complementary nature of these types of products. The hedge fund managers we are working with understand that this is a massive opportunity—and they see us as a good partner. If you are a small firm, it can be difficult to get any traction in the mutual fund business. We have a strong brand in the wirehouse, RIA, broker-dealer and defined contribution spaces, and have the distribution capabilities behind that, which contributes to our appeal.
How does the Fund approach investing?
Our process includes both investment and operational due diligence decisions. On the investment side, how we select hedge fund managers and construct the portfolio includes many steps that we have applied for years in our fund of hedge fund business. We look for strategies that we believe can do well in the current macroeconomic environment and, among those, we find best-of-breed managers for our Fund. Our selection process is both bottom-up and top-down, and has both analytical and quantitative elements. The operational decision is equally important because it supports the integrity of our whole process. We have a slew of requirements for managers, including SEC registration, business stability, controls and so on. If our operational team doesn’t like what they see, they have full veto power over the hiring of a new manager.
How does the Fund’s structure compare with those of other alternative funds?
There are several different structures out there that offer similar return characteristics. In the mutual fund space, you have single-manager funds, where a given portfolio manager specializes in a particular discipline, such as merger arbitrage or long-short equity. There are multi-manager products, like ours, but that is a very limited universe right now because operationally they are more complex to run; then there are funds that just invest in other ’40 Act funds, which are simpler to manage than a true multi-manager product.
Each structure has its pros and cons. The issue with a single-manager fund is that you’re not getting the potential benefits of multi-manager and multi-strategy diversification, and there are far fewer positions. As for the multiple fund structure, where you’re investing in other mutual funds, again the problem is cost, because you pay fees for the main fund and for the underlying funds it invests in. Also, you have limitations on the sizing of investments due to ’40 Act rules, so there’s not much flexibility. But with our structure, these issues are avoided, as we are investing using separately managed accounts.
How do you deal with the perception that alternative strategies are risky?
The perception of risk comes from two sources—performance and accountability. Clearly, there has been headline risk out there and people read about some big blow-ups, which get sensationalized. However, I think that in general people should look at alternative strategies as portfolio diversifiers and dampeners of volatility. In that context, when you look at 2008 and alternative strategy returns, they performed the way they were supposed to’outperforming the major equity indices in a down market.1
Also, in recent years, a few instances of fraud have received widespread attention. Obviously, it’s terrible when something like that happens, and I would say such situations are anomalous. However, the beauty of this structure is that investors may also benefit from Neuberger Berman’s risk management and oversight. That’s an important distinction.
1Hedging seeks to reduce the effects of a negative market but may limit performance in an up market. In 2008, hedge funds, as represented by the HFRI Fund Weighted Composite Index returned -19.03% while Equities, as represented by the S&P 500 Index returned -37.00%.
An investor should consider the Fund’s investment objectives, risks and fees and expenses carefully before investing. This and other important information can be found in the Fund’s prospectus or summary prospectus, which you can obtain by calling 877.628.2583. Please read the prospectus or summary prospectus carefully before making an investment.
The Fund’s performance will largely depend on what happens in the equity and fixed income markets. Shares of the Fund may be worth more or less upon redemption. The actual risk exposure taken by the Fund will vary over time, depending on various factors, including, Neuberger Berman’s methodology and decisions in allocating the Fund’s assets to subadvisers, and its selection and oversight of subadvisers. The subadvisers’ investment styles may not always be complementary, which could adversely affect the performance of the Fund. Some subadvisers have little experience managing registered investment companies which, unlike the hedge funds these managers have been managing, are subject to daily inflows and outflows of investor cash and are subject to certain legal and tax-related restrictions on their investments and operations.
The Fund’s returns may deviate from overall market returns to a greater degree than other mutual funds that do not employ an absolute return focus. Thus, the Fund might not benefit as much as funds following other strategies during periods of strong market performance. A subadviser may use strategies intended to protect against losses (i.e., hedged strategies), but there is no guarantee that such hedged strategies will be used or, if used, that they will protect against losses, perform better than non-hedged strategies or provide consistent returns.
Event Driven Strategies that invest in companies in anticipation of an event carry the risk that the event may not happen or may take considerable time to unfold, it may happen in modified or conditional form, or the market may react differently than expected to the event, in which case the Fund may experience losses. Additionally, event-driven strategies may fail if adequate information about the event is not obtained or such information is not properly analyzed. The actions of other market participants may also disrupt the events on which event driven strategies depend. Arbitrage Strategies involve the risk that underlying relationships between securities in which investment positions are taken may change in an adverse manner or in a manner not anticipated, in which case the Fund may realize losses. The Fund’s use of event-driven and arbitrage strategies will cause it to invest in actual or anticipated special situations—i.e., acquisitions, spin-offs, reorganizations and liquidations, tender offers and bankruptcies. These transactions may not be completed as anticipated or may take an excessive amount of time to be completed. They may also be completed on different terms than the subadviser anticipates, resulting in a loss to the Fund. Some special situations are sufficiently uncertain that the Fund may lose its entire investment in the situation.
Small- and mid-capitalization stocks trade less frequently and in lower volume than larger company stocks and thus may be more volatile and more vulnerable to financial and other risks.
Generally, bond values will decline as interest rates rise. You may have a gain or a loss if you sell your bonds prior to maturity. Bonds are subject to the credit risk of the issuer. The Fund’s performance could be affected if borrowers pay back principal on certain debt securities, such as mortgage- or asset- backed securities, before or after the market anticipates such payments, shortening or lengthening their duration.
Foreign securities involve risks in addition to those associated with comparable U.S. securities, including exposure to less developed or less efficient trading markets; social, political or economic instability; fluctuations in foreign currencies; nationalization or expropriation of assets; settlement, custodial or other operational risks; and less stringent auditing and legal standards. Exchange rate exposure and currency fluctuations could erase or augment investment results. Because an investment strategy used by a subadviser invests primarily in companies in Japan, the Fund’s performance may be closely tied to social, political, and economic conditions within Japan.
Derivatives involve risks different from, or greater than, the risks associated with investing in more traditional investments, as derivatives can be highly complex and volatile, difficult to value, highly illiquid, and a Fund may not be able to close out or sell a derivative position at a particular time or at an anticipated price. Non-U.S. currency forward contracts, options, swaps, or other derivatives contracts on non-U.S. currencies or securities involve a risk of loss, even if used for hedging purposes, if currency exchange rates move against the Fund. Investments in the over-the-counter market introduce counterparty risk due to the possibility that the dealer providing the derivative may fail to timely satisfy its obligations. Investments in the futures markets also introduce the risk that its futures commission merchant (FCM) may default on its obligations, which include returning margin posted a Fund. Derivative instruments can create leverage, which can amplify changes in the Fund’s net asset value and can result in losses that exceed the amount originally invested.
The Fund’s investments in ETFs subject it to such ETF’s risks as well as expenses. ETFs are subject to tracking error and may be unable to sell poorly performing stocks that are included in their index. ETFs may trade in the secondary market at prices below the value of their underlying portfolios and may not be liquid.
The Fund may engage in active and frequent trading and may have a high portfolio turnover rate, which may increase its transaction costs and may adversely affect performance.
The Barclays U.S. Aggregate Bond Index represents securities that are U.S. domestic, taxable and dollar-denominated. The Index covers the U.S. investment-grade, fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities. The S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a market value-weighted index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value. The “500” is one of the most widely used benchmarks of U.S. equity performance. Beta is a measure of the volatility, or systematic (market-related) risk, of a portfolio as compared to the overall market. The lower the beta, the lower the market risk (volatility). Standard Deviation (Risk/Volatility) is a statistical measure of the historical volatility of a mutual fund or portfolio.
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