Part of the surge in popularity of such investments is due to a push by hedge

Part of the surge in popularity of such investments

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Part of the surge in popularity of such investments is due to a push by hedge-fund firms and buyout groups to offer new retail products as part of a search for new growth as sales to their traditional institutional clients slows, according to a report last year by McKinsey & Co. Adding to some of the regulatory worries was the Securities and Exchange Commission's decision in July, in response to legislation passed by Congress, to permit hedge funds to advertise for the first time, which could increase the visibility of the products. "Our concern is there's a different atmosphere now," said William Galvin, Massachusetts' Secretary of the Commonwealth. "Regulations have been eased on advertising, and these firms are using more aggressive sales tactics." Mr. Galvin's office in July sent subpoenas to 15 securities firms demanding information on their sales practices of alternative products to seniors. Heath Abshure, Arkansas's securities commissioner and president of the North American Securities Administrators Association, said alternative investments are "one of our biggest investment problems, and all our members are looking at them." The number of alternative mutual funds has grown to 402 from 77 in 2003, and assets soared to $216.47 billion as of July from $11.2 billion at the end of 2003, according to Morningstar. In part, because these investments are more sophisticated, their managers often charge much more: The annual expenses can be more than 10 times those of traditional mutual funds, with commissions taking a larger bite out of the investor's capital. Regulators fear that some of the funds aren't listed on exchanges and can't always be sold quickly. That is an issue in a category known as non-listed business development corporations, or BDCs, which usually make loans to heavily indebted companies. Franklin Square Capital Partners, one of the largest managers in this area, is typical. Investors can put in as little as $5,000 in their BDCs and are charged more than 10% in initial commissions and annual expenses of about 6% for its funds, according to its prospectuses. The funds are advised by a unit of Blackstone and invest mostly in junk bonds. The yields have been more than 7% a year. Investors can usually sell only four times a year and receive just 90% of the net asset value of the fund.
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"We are not for everybody," said Michael Forman, Franklin Square's chief executive officer, who added that the commissions were similar to what brokers charge for initial public offerings. "We need for the clients to understand what the risks are...our health depends on their health." Write to James Sterngold at [email protected] A version of this article appeared August 16, 2013, on page C1 in the U.S. edition of The Wall Street Journal, with the headline: Mom-and-Pop Pitches Draw Flak.
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