Ainslie, Kingdon Trail Lower-Fee Hedge-Fund Clones
Chart for Hussman Strategic Growth Fund (HSGFX)
John Hussman runs a $6.3 billion mutual fund with the flexibility to bet on rising and falling stock prices. His fees are a fraction of those charged by so- called long-short hedge funds that do the same thing, and he’s making more money for investors this year.
Hussman Strategic Growth Fund climbed 2.35 percent through July 30, compared with an average decline of 1.22 percent for stock hedge funds tracked by Chicago-based Hedge Fund Research Inc. Hussman is outpacing some of the most highly regarded stock-pickers in the hedge-fund world, including Maverick Capital Ltd.’s Lee Ainslie, Andreas Halvorsen of Viking Global Investors LP and Mark Kingdon of Kingdon Capital Management LLC.
U.S. mutual funds that can hedge their holdings by selling short are luring investors by protecting them in volatile markets and allowing daily withdrawals. Clients poured $8.95 billion into long-short mutual funds in the first half, bringing assets to $41 billion. That compares with deposits of $10.3 billion in all of 2009, according to data compiled by Chicago- based Morningstar Inc.
“You can find great managers with long track records, the minimums are low and you can get your money out the next day,” said Brad Alford, head of Alpha Capital Management LLC in Atlanta, which selects hedge funds and other investments for its clients, said of long-short mutual funds.
Alford created a fund of funds that mixes long-only, short- only and long-short mutual funds that has returned about 15 percent since its start 18 months ago. That compares with a gain of 10 percent by Hedge Fund Research’s index of funds that invest in other hedge funds.
Hedge funds, which oversee $1.6 trillion, attracted $23 billion in new cash in the first half. They usually charge investors 2 percent of assets under management and 20 percent of investment profits, and allow withdrawals quarterly or annually.
Fees at long-short mutual funds average 2 percent of assets, according to Morningstar, and share classes designed for institutions or retirement plans can be lower. The funds, which allow investors to redeem their shares daily, don’t take a cut of gains.
The Chicago Board Options Exchange Volatility Index tripled in May from April as the debt crisis in Europe sparked a decline in equity markets worldwide. While the VIX index has since decreased, it remains 11 percent above the average over its two- decade history, according to data compiled by Bloomberg.
Many long-short mutual funds have usually underperformed their hedge-fund counterparts, said Larry Chiarello, a partner at SkyView Investment Advisors LLC in Shrewsbury, New Jersey, which selects investments for clients. One reason is that conventional managers tend to be more long-biased, meaning that more of their bets are concentrated on stocks they expect to rise. They generally aren’t as good at shorting, or picking shares they expect will tumble, he said. They also tend to trail in strong bull markets.
Another reason is that U.S. Securities and Exchange Commission rules limit to one third of assets the amount of money mutual funds can borrow to amplify returns. Hedge funds, which face looser SEC regulation because they are open only to institutions and wealthy investors, often borrow at least twice their assets.
While the cap on leverage generally means long-short mutual funds won’t lose as much money when wagers go wrong, it curbs gains when they are right.
This year, their weaknesses have turned into strengths.
Long-short mutual funds mostly short indexes or groups of stocks using exchange-traded funds or derivatives known as futures. Hedge fund-managers tend to more frequently short individual stocks or bonds.
The correlation within and between asset classes is at historically high levels, meaning that when bad news comes out, stocks are all falling together, and good economic data is sending everything higher, said Geoff Bobroff, president of Bobroff Consulting Inc. in East Greenwich, Rhode Island. That gives an advantage to mutual funds because they are betting on broad segments of the market rather than specific securities.
“The market has been trading within a range and that suits the sort of trading and shorting these mutual funds use,” he said.
One of the best performing mutual funds this year is the $273 million Weitz Partners III Opportunity Fund, managed by Wallace Weitz in Omaha, Nebraska. The fund, which advanced 17 percent this year through Aug. 2, has been wagering on a decline in small and midsize stocks with ETFs, he said in an interview.
Weitz, 61, uses short-selling mainly as a strategy to hedge against broad-based market declines. He prefers to buy what he calls “mispriced” stocks that are trading below what he believes is the real value, based on measures such as earnings and cash flow.
“We think of our approach as a go-anywhere mutual fund,” said Weitz, whose fund isn’t in Morningstar’s long-short category even though he has a short position equal to about 16 percent of assets. “We have extra tactics with this fund, so it’s as flexible as can be.”
Weitz has benefited this year from a long position in Coinstar Inc., a Bellevue, Washington-based operator of coin- counting machines, which has jumped 69 percent.
Pacific Investment Management Co., the Newport Beach, California-based firm run by Mohamed El-Erian and Bill Gross, has been one of the biggest beneficiaries of investor interest in what are sometimes called hedge-fund clones, attracting $3.3 billion to its Pimco Fundamental Advantage Fund in the past 12 months. It is run by Rob Arnott of Research Affiliates LLC.
The $4.3 billion Fundamental Advantage mimics Gross’s holdings in Pimco Total Return Bond Fund, the world’s largest mutual fund, and goes long on stock indexes designed by Arnott that are built around financial metrics such as sales and earnings. It shorts the Standard & Poor’s 500 Index, a benchmark of U.S. companies that is based on their market capitalization. It gained 9.3 percent this year through Aug. 2.
“The fund can be seen as hedge-fund lite, not in returns but in terms of level of risk, leverage and fees,” Arnott, who is also based in Newport Beach, said in an interview. “With most hedge funds the only thing you’re absolutely assured of is high fees.”
Fundamental Advantage has annual expenses of 2.89 percent for investors who purchase the fund through its retail share class and 0.89 percent for the institutional-share class, which is available to 401(k) investors.
Reliability the Goal
The fund rose about 1 percent from its start in March 2008 through the end of that year, while the S&P 500 index fell 32 percent. It added 16 percent in 2009 as the S&P 500 returned 24 percent, data compiled by Bloomberg show.
“People who buy the fund to beat a bull market in stocks are making a mistake,” Arnott, 56, said. “The goal of this fund is to earn reliable, steady returns.”
Like Arnott, Hussman, 47, has done a better job of protecting capital than producing outsized returns. Strategic Growth Fund, which charges investors 1 percent of assets, has gained an average of 14 percent a year since it opened in July 2000.
Hussman was a professor of economics and international finance at the University of Michigan before he became a money manager. The investor, whose Hussman Econometrics Advisors Inc. is based in Ellicott City, Maryland, invests in stocks and shorts major indexes, and uses options to enhance his positions.
He’s expecting that this year performance will remain volatile.
“My impression is that the economic cold water could hit investors very abruptly, so that gains achieved over several weeks may be suddenly erased in a matter of a few days,” he wrote in a weekly report posted on his firm’s website on July 26.
Halvorsen’s Viking Global Equities fund fell 2.56 percent this year through July 23. The Greenwich, Connecticut-based manager has returned an average of 20 percent annually since starting in September 1999.
Ainslie’s Maverick Fund, based in New York, is down 0.3 percent this year. The fund has an average annual gain of 14 percent since inception in March 1995. New York-based Kingdon’s largest fund rose 1.6 percent through July, and averaged a return of about 17 percent a year since February 1986.
Executives at Viking, Maverick and Kingdon declined to comment on their returns.
The 261 long-short mutual funds tracked by Morningstar have fallen an average of 1.5 percent this year.
Investors have been looking to mutual funds even if the returns trail hedge funds because they want to be able to exit their investments at will, said Rick Lake, co-chairman of Greenwich-based Lake Partners Inc., which advises institutions on $3.5 billion in assets and has invested $100 million with mutual funds that can hedge.
In 2008, more than 18 percent of hedge-fund assets were subject to restrictions on withdrawals, according Singapore- based hedge-fund consulting firm GFIA Pte.
“Alternative mutual funds got through the crisis without the failures in illiquidity,” Lake said in an interview. “The tortoise with the harder shell beat the hare.”
The quest for quick withdraws is also driving demand for so-called Ucits funds, which gathered 108 billion euros ($142 billion) through the first five months of 2010, according to the European Fund and Asset Management Association.
Ucits, usually based in Luxembourg or Dublin, are regulated funds that allow investments on rising and falling prices through the use of derivatives. Their name is an acronym for Undertakings for Collective Investment in Transferable Securities.
Chiarello of SkyView said he expects the caliber of long- short mutual funds to improve because more hedge-fund managers may get into the business, as they are already doing with Ucits.
“There are more people willing to do a managed account in a mutual-fund product,” he said.
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