Monday, March 22nd, 2021 and is filed under Alternative Strategy Mutual Funds
What Happened
On Monday, February 22, 2021, the Infinity Q Diversified Alpha Fund (Fund) and its investment adviser, Infinity Q Capital Management (Infinity Q), sought and obtained an order from the Securities and Exchange Commission (SEC) permitting the Fund to suspend redemptions indefinitely. The Fund is expected to liquidate assets and distribute the proceeds to shareholders with the assistance of a third-party valuation service and the oversight of the SEC’s Division of Investment Management[i]. At this time, there is no estimate of when the liquidation and distribution will be completed. Until then, redemptions of Fund shares will remain suspended[ii].
Why It Happened
The Fund invested according to an alternative investment strategy that primarily used complex derivative instruments to derive intended exposures. According to the Fund’s most recent financial statement, this included correlation swaps, dispersion swaps, and variance swaps, among various other contracts. Adding to the complexity, a significant portion of these assets were categorized as Level 3 for which market prices are not readily available[iii]. For such securities, third-party services are required in estimating the fair value for purposes of calculating the Fund’s net asset value (NAV).
Based on information learned by the SEC and shared with Infinity Q, it was determined the Fund’s portfolio manager had been adjusting certain parameters within the third-party pricing model being used to estimate the fair value of the Fund’s swap contracts[iv]. Upon review, Infinity Q released the Fund’s portfolio manager, who is also the firm’s CIO and Founder, and determined that it was unable to value the current positions nor confirm the historical values of the Fund’s swap contracts. Presumably to avoid a “run on the bank” situation, which can lead to depressed prices and further losses for investors, Infinity Q sought the order from the SEC while it enlists the services of an independent valuation firm to calculate an accurate NAV for the fund.
Key Takeaways for Alternative Mutual Fund Investors
Despite the increased regulatory oversight of the mutual fund structure, relative to private funds and hedge funds, financial professionals and investors must exercise caution when using alternative mutual funds (AMFs). This is due to the increased complexity that may be present within the product structure including short positions, derivatives instruments, illiquid investments, and leverage. The complexity broadens the opportunity set of these funds allowing portfolio managers to pursue non-traditional investment strategies that may provide enhanced portfolio diversification, systematic risk reduction, and alternative sources of return. However, they may also increase risk and reduce transparency for investors, as demonstrated by the recent developments in the Infinity Q Diversified Alpha Fund. As such, consider the following:
iCapital Network[1]
AI Insight by iCapital Network currently offers an AMF platform designed to provide financial firms and advisors a comprehensive tool for research with a focus on education and application (versus an investment rating). The platform is a web-based, subscription service and consists of two main components specific to AMFs:
The platform focuses on mutual funds with alternative investment strategies consistent with the hedge fund industry. Funds covered by the platform are portfolio oriented and will typically have a minimum 2-year track record and $200 million in AUM.
The platform currently covers the Fund on a limited basis. As part of our fund-level research, we have a tiered system that includes full and limited reviews. The former includes investment due diligence summarized within the report while the latter aggregates only the available public data. Considering the Fund’s developments, the platform is actively pursuing ways to improve our process including an increase in our screening parameters for limited reviews, enhancing the existing derivative contract reporting, and summarizing Level 3 assets within each report.
For more information on the platform, please contact AI Insight Customer Care at (877) 794-9448 ext. 710 or via email at customercare@aiinsight.com.
Infinity Q Diversified Alpha Fund
The Fund sought to generate positive absolute returns by combining risk management with diversified alpha strategies. Per the latest summary prospectus, the four primary strategies included Volatility, Equity Long Short, Relative Value, and Global Macro. The investable universe included global markets across equities, fixed income, commodities, credit, and foreign exchange.
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Endnotes
[1] Institutional Capital Network, Inc. and affiliates (herein “iCapital Network”)
[i] Securities and Exchange Commission. https://www.sec.gov/rules/ic/2021/ic-34198.pdf
[ii] Infinity Q Capital Management, LLC. http://www.infinityqfunds.com/
[iii] Financial Accounting Standard 157 (FAS 157). https://www.investopedia.com/terms/f/fasb_157.asp
[iv] Securities and Exchange Commission. https://www.sec.gov/rules/ic/2021/ic-34198.pdf
[v] The Economics of Derivatives. https://www.nber.org/digest/jan05/economics-derivatives
[vi] FINRA Investor Alert. https://www.finra.org/investors/alerts/alternative-funds-are-not-your-typical-mutual-funds
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