Hedge Funds X Mutual Funds

Both sides now
More mutual funds are using strategies such as short selling once allowed only in hedge funds
(From The Denver Post, provided by LexisNexis) April 17, 2007 Tuesday

The line between hedge funds and mutual funds is becoming increasingly blurred as a growing number of money managers introduce mutual funds that use strategies once limited to hedge funds.
What's more, some hedge-fund managers, who historically catered only to the most wealthy, are now offering their services through mutual funds, which are accessible to a wider group of investors.
The trend is providing average investors with a low-cost way of diversifying their portfolios through the use of hedging strategies - a category of investing techniques often too complex or risky for most small-
time investors.
Since 2003, the number of hedge-fund-like mutual funds, also called "long-short" funds, has more than doubled, increasing from 25 to 53 funds, according to investment researcher Morningstar. Long-short funds allow asset managers to buy stocks as well as sell stocks short, a technique used to profit from the falling price of a stock.
Denver-based Janus Capital Group, for instance, rolled out a long-short fund last August. The fund has attracted $50 million in investment since then.
Jerry Paul, head of Greenwood Village-based Quixote Capital Management, ran a hedge fund for years before introducing a mutual fund in 2005.
"It moved me into a whole new market," Paul said, who uses a hedging strategy in which he simultaneously buys into both sides of a merger-and-acquisition deal.
Paul's hedge fund has a $1 million minimum. Investors can get into his mutual fund for as little as $2,500.
The number of portfolio managers simultaneously operating mutual funds and hedge funds has increased from 80 three years ago to 124 today, according to Morningstar. In 2000, just 31 portfolio managers used such a side-by-side approach.
Hedge funds, or private investment partnerships lightly regulated by the U.S. Securities and Exchange Commission, are typically used by the wealthy. The funds are open only to accredited investors - those with at least $1 million in net worth or $200,000 in annual income.
Running mutual funds alongside hedge funds is attractive to money managers for several reasons, Paul and others said.
Hedge funds offer stock pickers greater compensation than mutual funds. Most hedge funds charge a base fee of 1 percent and then take 20 percent of profits. By comparison, mutual funds have an average expense ratio of 1.41 percent, according to researcher Lipper Inc.
The lucrative pay structure has allowed hedge funds to lure talented money managers away from mutual funds. In response, some mutual-fund companies are launching hedge funds as a means to retain top talent, said Ryan Tagal, a director with Morningstar. However, Tagal said small-time investors are potentially shortchanged if fund managers spend more time managing their hedge fund compared to their mutual funds.
"There are potential conflicts of interest," Tagal said. "Perhaps they will buy stocks for the hedge fund before they buy it for the mutual fund."
The interest in hedge funds and hedge-fund-like mutual funds boomed after the bear market of 2002-03, said Todd Trubey, a senior analyst with Morningstar.
Trubey said hedge funds outperformed mutual funds during that time, largely because the hedge funds were able to sell stocks short - a tactic that most mutual funds can't use.
"The reason the funds have appeal is that they do well in a rising market and in a falling market," Trubey said. But, he noted, long-short funds tend to lag most stock funds during bull markets.
Long-short funds have posted an average annual return of 6.5 percent since 2003. By comparison, the Standard & Poor's 500 has gained 14 percent per year during that span.
"Unfortunately, asset managers oftentimes show up at the party just as it's ending," Trubey said.
Staff writer Will Shanley can be reached at 303-954-1260 or .