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December 15, 2005
Mutual funds in hedge funds' clothing
In perhaps another sign that hedge funds have peaked, a growing assortment of mutual funds masquerading as hedge funds are trying to appeal to the masses.
These funds, 54 of them tracked by Morningstar so far, are more expensive than typical mutual funds but far less costly than trying to get in on a top hedge fund. Managers point out that though they won't match the spectacular returns of some of the best hedge funds, these mutual funds offer more safeguards for individual investors.
Household names such as Franklin, PIMCO, Schwab and JPMorgan Chase, all run such funds, and there are even several well-known hedge fund managers with mutual fund offerings, including Gabelli, Gartmore and Calamos.
On Monday, UBS, the giant Swiss banking company, unveiled its third such mutual-fund-in-hedge-fund-clothes this year, the US Equity Alpha fund, which is supposed to target better returns than the Russell 1000 index by investing long and short-selling, or betting the price of a certain stock will fall.
In March, UBS introduced its Absolute Return Bond Fund, which has $247 million in assets and a return so far of 1.3%. It introduced the Dynamic Alpha Fund in January, with $1.1 billion of assets and a return so far of 6%.
In October, David Winters, a protégé of activist shareholder Michael Price and the former chief executive overseeing $35 billion of investments at Franklin Mutual Advisors, began trading the Wintergreen Fund, another mutual fund that acts like a hedge fund. Its prospectus outlines its plan to invest in undervalued stocks, bankrupt companies and private placements and engage in arbitrage and shareholder activism.
"Everyone's gone in one direction" setting up hedge funds, Winters says. "We thought that there was a big opportunity with a mutual fund."
Investment advisers say there are some advantages to buying into mutual funds rather than hedge funds. Regulators won't let a mutual fund take on the same amount of leverage as a hedge fund, and mutual funds can't invest as much in thinly traded shares. Moreover, mutual fund investors have the benefit of being able to cash out whenever they want; hedge fund investors usually have 30-45 day notice periods and can only really cash out once or twice per year (assuming they've had their money in a fund through the lock-up period.)
Typical mutual funds in this category have expenses of 1.5% to 2% annually--far higher than the 1.35% for plain old funds, but far less than the 2% management fee and 20% take on profit a typical hedge fund manager demands.
And the real kicker: Mutual funds are more closely monitored than hedge funds, at least for now. That means there's less likelihood that the manager will take the money and run. "It's a safer way to go for the average person," says New York investment adviser Lew Altfest.
Wintergreen is up 2% since its birth two months ago, better than many hedge funds, which had a rough October. (The Hennessee hedge fund index was negative 1.3% in October, rebounding to positive 1.4% last month.) Winters won't say how big the fund is, but he says he is attracting interest from direct sales and expects the fund to be offered through advisers and brokers soon.
Of course, less downside risk may also mean less upside. Because they're not taking on as much leverage and engaging in riskier trades, mutual funds aren't likely to match the best-performing hedge funds. Plus, it's hard to overcome that hedge fund snob appeal.
Robert Gordon, chief executive of New York-based investment firm Twenty-First Securities, recalls his own firm's attempts to run a mutual fund with a hedge fund style. It was literally the pioneer, introducing a long-short mutual fund in 1985 under the management of now legendary money runner Robert Stovall.
The fund made it to early $70 million in assets, but Twenty-First Securities threw in the towel anyway. By the time the fund got moving, the stock market had taken off, and it was not able to match the returns of some of the more aggressive stock funds. Gordon says the fund never became profitable. People were buying it to get access to Stovall, not because they thought it was a great invention.
Gordon says he still thinks they're a good idea. "But they don't have the same cache" as a hedge fund. "You don't get the same thrill."
-Forbes-
Posted by su at December 15, 2005 11:32 AM