The mutual fund industry sems to scrambling to find a new way to entice individual investors. With fewer and fewer investors buying into the active managers claim of stock picking skill, we are now faced with a variety of "absolute return", "long short" or go anywhere funds sold as a way to get access to active managers able to spin gold out of yarn : positive returns whatever the market conditions with less volatility to boot.
The WSJ reports today on another wrinkle to this group of
products the hedge fund like mutual fund which the article notes perform this ambitious feat:(my bolds and comments in blue)
Hedged mutual funds provide stock-like returns with less volatility. Moreover, they provide more transparency and regulation than hedge funds. "We think there'll be a huge move to these types of funds," Mr. Krusen said.
Hedge funds take short positions, bets on falling prices, as well as long positions that benefit from rising valuations. They also can use borrowed money, or leverage, to magnify returns. They usually lock investor money up for a quarter or more, and some are free to trade any securities or derivatives anywhere in the world.
The goal is to generate positive returns, irrespective of the direction of the overall market. This is usually all wrapped up in a limited-partnership structure in which the manager charges an annual fee of 2% or so and takes about 20% of profits each year.
Traditional mutual funds typically take long-only positions and try to beat benchmarks, such as the S&P 500-stock index. The average net expense ratio of mutual funds is about 1.3%, according to Morningstar. Mutual funds don't take any cuts of profits. In contrast, the Flexible Fund's net expense ratio is 3%, according to Morningstar.
It's not hard to understand why this structure might appeal to managers like AQR management that previously only managed hedge funds. Hedge funds typically charge "2 managementand 20% of profits " But if the fund suffers large losses the 20% can only be charged once the fund recovers to the "high water " mark. So with a 30% loss a hedge fund manager would have to recover 42% before beginning to collect the performance fee. This structure led many hedge fund managers to simply close their funds return the money to investors....and start fresh with a new fund. It doesnt take a quant PhD to do the math that 3% annual fee from retail investors would likely be a better trade than "2 and 20" in a hedge fund, particularly when institutional investors have been pushing back for lower fees.
Investment bank Goldman Sachs Group Inc., one of the largest hedge-fund managers in the world, advised investors to add this new breed of mutual fund to their portfolios in a September report. The 2008 financial crisis left many uncertain about whether a traditional mix of stocks and bonds can generate enough return, the bank said.
As noted earlier by a previous study, hedge fund assets keep rising and investors keep putting more new money into managers’ hands.Maybe the smart money is not in the flows described above but among the bifg flows into etfs.shown in the graph at the top of the page.
As long as returns are relatively positive, that’s likely to be the case for awhile longer.
In October, the trend we’ve been seeing of improving hedge fund performance continued. As a whole, hedge funds gained 2% in the month, according to the Barclay Hedge Fund Index compiled by BarclayHedge.
After back-to-back gains in the past two months, the index this year was up 7.24% — nearly matching the 7.84% return of the S&P 500 benchmark.