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Mutual funds copy hedge fund strategies in turf war

Date: Monday, May 25, 2009
Author: Herbert Lash - Analysis, Reuters.com

Mauled by the carnage on Wall Street, mutual funds are copying hedge fund strategies in an effort to regain some of the shine they have lost this decade.

Many investors have been burned investing in a single asset class and withdrew $234 billion from U.S. stock funds last year as the deep bear market sparked the first annual outflow of long-term investment in mutual funds since 1988.

But as stocks sank, hedge funds soared. The Standard & Poor's 500 Index .SPX, a benchmark for the broad U.S. stock market, returned a negative 40 percent this decade through the end of 2008. Hedge funds, meanwhile, gained 55 percent over the same period, Hedge Fund Research's fund-weighted composite index shows.

The basic strategy of bridging more than one asset class and being able to bet a security will decline, instead of just rise, promises two key traits of hedge funds: less volatility than mutual funds and less correlation to stocks.

"Style boxes are dead, at least for the moment," said Chuck de Lardemelle, a portfolio manager and co-founder of asset management firm International Value Investors, referring to the narrow investment perspective of equity- or bond-only funds.

IVA has a "go-anywhere" investment style that has helped assets under management, including separately managed accounts, more than quadruple to almost $2.2 billion as of April 30 since the firm launched its mutual fund on October 1.

"Investors are looking for managers able to understand and invest in different asset classes. We hear the same message loud and clear from many investors," said de Lardemelle.

Client demand for flexible portfolios led Turner Investment Partners LLC to launch a mutual fund last week called Spectrum, said Matthew Glaser, director of alternative investments at the firm, which oversees about $14 billion in assets.

Spectrum TSPEX.O will invest in six of the long-short equity strategies employed in Turner Investment's separately managed accounts for high-net worth investors.

"We call this a multi-strategy hedged equity fund," Glaser said. "But many folks are going to view the advantages of this being in a mutual fund structure," he said.

The nascent offerings, while still at an early stage with a limited performance history, may blunt the enormous money flows that have led assets under management at hedge funds to more than double this decade to about $1.3 trillion.

Spectrum "will not only take share from hedge funds, but fund of funds as well," said Bob Turner, chairman and chief investment officer at his namesake firm.

And mutual funds have advantages of their own over hedge funds: lower fees, higher liquidity and more transparent investment strategies, and daily pricing. Hedge funds use leverage and may take greater risks, which can benefit or be a detriment to performance.

"It's very clear, particularly in today's markets, that all the structural impediments, all the structural problems of hedge funds have really became apparent: the lack of liquidity, the lack of transparency, the high fees," said Adam Patti, founder and chief executive of IndexIQ, a Rye Brook, New York, company with two products that replicate hedge fund returns.

Hedge funds have gained attention because of their high returns, but they also took heat for a decision by some to "gate" investments and stop redemptions last year after markets plunged following the Lehman Brothers bankruptcy in September.

Many investors also find they cannot invest in hedge funds, even registered investment advisers, said Patti, whose IQ ALPHA Hedge Strategy Fund was added to Fidelity Investments' mutual fund platform early in May.

"Even the typical-sized RIA really couldn't access the best-of-the best," he said. "That said, there are great hedge funds out there, and if you can get into them, get into them."

New funds keep rolling out. Putnam Investments this week launched two new funds -- Putnam Capital Spectrum Fund PVSAX.O and Putnam Equity Spectrum Fund PYSAX.O -- that will invest across a company's capital or equity structure, including stocks, bonds, bank loans and convertible securities.

Another fund, Goldman Sach's Absolute Return Tracker Fund GARTX.O, has done well since it was launched a year ago considering the fund's unique approach, said Glen Casey, a managing director at Goldman Sachs Asset Management.

Since inception on May 30, 2008, the Goldman fund is down 12.8 percent as of Monday, compared to the S&P 500's 35 percent decline, according to Lipper.

Although geared toward individual investors, the fund has enjoyed some interest from smaller institutional investors as a complement to their alternative investments because of its liquidity, Casey said.

The question the new funds pose is whether they represent competition to hedge funds.

For Troy Buckner, managing principal at NuWave Investment Management LLC, a hedge fund in Morristown, New Jersey, whose flagship fund is a managed futures accounts, interest in the alternative space is an opportunity.

"We see this as a potential boon to our business," said Buckner, noting that Deutsche Bank is launching an ETF, possibly as early as June 1, that will encompass six managed futures advisers, including NuWave Investment, he said.

Deutsche Bank declined to comment.

"To the extent that gains popularity worldwide, it's just expanding the reach to the retail investor we don't have the opportunity to reach directly," Buckner said.

(Editing by Leslie Adler)