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Volatile market a test of hedgelike strategies

Date: Tuesday, September 18, 2007
Author: Jeff Benjamin, Investment News

 Alpha Hedged Strategies, Beta Hedged Strategies attract inflows amid market volatility

Last month, when the stock market was volatile and many investors started running toward any kind of stability, Lee Schultheis accepted the situation as a good test for his investment strategy.

Mr. Schultheis, co-founder and chief investment officer of Alternative Investment Partners LLC in White Plains, N.Y., saw record inflows last month into his two mutual funds.

The bulk of the $78 million in net inflows went into the $595 million Alpha Hedged Strategies Fund (ALPHX). But the newer and more aggressive $18 million Beta Hedged Strategies Fund (BETAX) also captured some of the August inflows.

Both funds essentially were flat last month, which is in sync with most of the major stock indexes, but the daily net asset values of the funds didn’t experience the same level of volatility as the overall market.

“The key is multistrategies and diversification,” Mr. Schultheis said. “And August was a classic example of how it works.”

Mr. Schultheis isn’t your typical mutual fund manager, which is why he often compares himself with managers of funds of hedge funds.

“You want to be in a broad variety of categories, and we have all the categories of a traditional fund of hedge funds,” he said.

Although both the five-year-old Alpha Hedged Strategies and the 17-month-old Beta Hedged Strategies are registered mutual funds, they are structured more like funds of hedge funds. The basic strategy involves allocating the mutual fund assets to hedge fund managers who then manage the money in accounts separate from their respective hedge funds.

When he introduced the concept five years ago, Mr. Schultheis established subadvisory relationships with three hedge fund managers.

Today, Alpha Hedged Strategies, which will surpass the crucial five-year mark Sept. 23, allocates its assets to 22 underlying hedge fund managers. Beta Hedged Strategies, which launched in April 2006, uses 18 of those managers.

Ultimately, according to Mr. Schultheis, the platform could support about 100 hedge fund managers, with each managing between $100 million and $150 million.

But that is way down the road. For now, Mr. Schultheis is just enjoying how far his strategy has come since he first started explaining the concept to financial advisers.

These days, the funds are starting to expand beyond the independent-adviser channels and are gaining popularity among a wider network of brokerage representatives.

One hurdle that isn’t likely to go away and deserves some explanation is the 3.99% total expense ratio for each of the funds.

There is no getting around the sticker shock, especially when the expense ratio is compared with the 1.31% average total expense ratio for all mutual funds tracked by Morningstar Inc. of Chicago.

Mr. Schultheis justifies the higher fees by comparing them with the fund-of-hedge-funds industry, where a 1% management fee and 10% investment performance fee typically are added to the 1.5% management fees and 20% performance fees of the underlying hedge funds.

He doesn’t disclose the details of the fee arrangements he has with individual hedge fund managers, but he pointed out that there are no performance fees attached to his mutual funds.

“Fees used to be more of a stumbling block when we didn’t have much of a track record,” Mr. Schultheis said.

Other significant distinctions between his mutual fund structure and a traditional hedge fund are that his controls the use of leverage and has full transparency with regard to the underlying positions.

Both funds are exposed to a range of hedging strategies, including convertible bond arbitrage, merger arbitrage, global hedged income and equity options.

Alpha Hedged Strategies applies a market-neutral strategy that is designed to limit risk by maintaining a generally neutral exposure to the overall markets.

It also uses less leverage than Beta Hedged Strategies, which employs a more aggressive long-short strategy.

Beta Hedged Strategies is managed to provide 100%-long exposure and between 30% and 70% exposure on the short side.

The use of leverage, which is adjusted based on market conditions, also is offset by the amount of cash held by the underlying managers.

“In July, we could see the storm coming, so we used a lot of our inflows to pay down and reduce our leverage in the funds,” Mr. Schultheis said.

Year-to-date through last Thursday, Alpha Hedged Strategies had gained 6.2%, while Beta Hedged Strategies had risen 8.7%. The Standard & Poor’s 500 stock index had risen 4.6% over the same period.

Questions? Observations? Stock tips? E-mail Jeff Benjamin at jbenjamin@crain.com.