New Look for Hedge Funds This Summer: Mutual Funds

Despite the aversion retail investors have recently had towards hedge funds, the hedgification of traditional investments is apparently continuing in some quarters of the money management business.

Back in March, Chip Roame, the founder and CEO of Tiburon Strategic Advisors told the online newsletter Advisor Perspectives that:

Absolute returns and more broadly non-correlated assets are likely to be a growing part of the investing market. Consumers will seek out advisors and institutions that offer non-correlated assets. These strategies will come back and grow within the 40-Act universe and among traditional hedge fund product structures. Investors have paid such a dear price in the current market, and they want to believe that some smart guy can figure out how to properly diversify and reduce risks.

One group of possible “smart guys” at UK manager Gartmore has just announced its entry into the retail hedge fund market. Gartmore’s Phil Wagstaff recently told Reuters that:

The hedge fund world and the UK retail world will collide - we see this as a core area for us going forward and we see this as a growth area for the industry…

Wagstaff goes on to say that “genuine” hedge funds with little to no market beta will remain in demand by retail investors seeking true diversification. (Notably, the firm plans to actually hire several senior staff to handle new business like this one after laying off several dozen last year).

The interest among traditional managers in buying or launching hedge funds is spreading faster than the swine flu. Aberdeen Asset Management is shopping for beaten-down funds of funds. Its chief executive told Reuters this week that:

We like the fund of hedge funds area and that’s become more and more attractive over the past six months as valuations have collapsed in that sector as the assets under management have fallen dramatically…

Touche!

It will come as no surprise that the counter-trend - the traditionalization of hedge funds - also continues unabated. As the Wall Street Journal reported last month, hedge fund stalwart Permal launched its first mutual fund under the banner of “Tactical Allocation”.

According to the firm’s marketing literature, the fund can short up to 40% of NAV and is long in equities, fixed income and cash. But according to the April 16 manager commentary, there were no short positions in the fund (other than short positions that might have been contained in the paltry 4.9% allocation to actual hedge funds).

Of course, the mutual funds launched by hedge fund companies needn’t be predominantly long-only. You may remember hedge fund AQR’s January entree into the mutual fund business with the AQR Diversified Arbitrage Fund. According to data from Morningstar, the fund has all the juice of a typical hedge fund offering including short-selling and leverage:

Critics of the hedge fund industry have always derided the “hedge fund model” (fees, less regulation, secrecy, yada yada yada). But the popularity of hedge fund strategies in a Ucits or mutual fund structure is living proof that the fundamental shift to alpha-centric investing continues.

Comments

[RiskReturnO...:]

Great article. I'm been waiting for this to happen.

The retail brokerages are still selling their old methodology: 60%Stock/40% bond or whatever mix based on age, buy and hold forever, dollar cost average by buying into bubbles, spread over value/growth big/small cap nine squares style map, ....... modern portfolio theory stuff .... and hoping that after 10 years of complete disaster, people will continue to believe them for another 10 years.

They continue to use "diversification" as excuse for poor performance. For example, even though they know treasuries are terrible now, it's still part of that bond "pie"; US dollar is risky, US equities is still the biggest slice of the stock "pie"; Europe and Japan economies are bigger than BRIC, so their share of the international "pie" has to be bigger. How can diversification lead to superior risk reward if you end up participating in each bubble area despite knowing in your guts that you are buying at the tops?

I've been looking for a 21st century modern portfolio theory that captures long/short equities, commodity, interest rate plays, currency plays, equity distribution not based on GDP of each country (most people own way too much US, Japan, Europe), capital structure arbitrage (long convertible / preferred / high yield, short common), options for risk management, etc. So far, there is no easy way for the retail investor to do this, besides relying on the growing list of ETF's. Actually, thank god the ETF industry has come up with some great products for retail investors to attempt to create a new modern portfolio using things such as GLD, DBA, TBT, DBV, USO, JNK, SDS, FXI, ... so that the diligent ones can still retire someday.

What we need is for some academic / researcher to "certify" that the methodology of MPT is flawed in today's investment environment, and that true return / risk optimization cannot be achieve through "asset allocation between stocks and bonds". It needs to involve currency, interest rate, commodities, long/short, capital structure arbitrage, options/managed futures, taking into account the new globalized work that we live in. We need some white paper on the optimal mix of asset classes in the new world that we all live in -- and traditional 60%/40% mix is not hurting the dreams of many Americans saving for retirement, college, etc.

May 09 05:56 PM