These days, it seems everyone wants to get into a hedge fund. Even the blowup of Long-Term Capital Management and the problems of legendary hedge fund managers Julian Robertson and George Soros have not dampened investor demand. But the people at these high-reward investment pools won't even talk to you unless you can ante up $100,000--and many of the best-known have a $1 million minimum, if they're taking in new investors at all.
Sensing an opportunity, mutual fund companies are rolling out their own versions of these elite investments: "long-short" funds. These mutual funds can do what hedge funds do: buy securities, sell them short, and leverage the portfolio through margin-borrowing or derivatives. But unlike hedge funds, their minimum investments range from $1,500 to $10,000--and you can cash out anytime.
There are only a handful of long-short funds around, including three from AIM Advisors, the Montgomery Global Long-Short Fund, and the latest, the INVESCO Advantage Fund, which launched on Aug. 25. Fund industry folks expect lots more, thanks in part to 1997 tax law changes that made it easier for mutual funds to engage in short sales.
As part of a larger portfolio, a long-short fund can act as a portfolio diversifier, because such funds don't move in lockstep with broad market indexes. This year, for instance, the Standard & Poor's 500-stock index has had a bumpy ride but shown little net change. Yet several of the long-short funds boast returns in excess of 35%, thanks to their adroit short-selling of technology stocks during this spring's market rout. The best performer is AIM's Large Cap Opportunities Fund, which launched in December and is up 44.5% for the year through Aug. 31. (The fund plans to close to new investors on Sept. 29.) Another winner is Needham Growth Fund, which targets small and medium-size companies' stock and is up 39.4%, on top of a 79.7% gain in 1999. By contrast, the average U.S. equity fund, which purchases stocks but usually doesn't sell short, has returned 11% so far this year, according to Morningstar.
PICKY PEOPLE. While long-short funds have the ability to profit in both up and down markets, that flexibility alone doesn't guarantee success. More important is how they execute their bold strategies, which often involve making big bets in hot market sectors and magnifying those positions with leverage. "These funds rely heavily on their stock-picking prowess," says Rick Lake, an investment consultant in Greenwich, Conn.
Consider the three-year-old Montgomery Global Long-Short Fund, which surged 135.1% in 1999 after a 53.4% gain in 1998. This year, however, the fund is up just 5.2%, hurt during the spring by its long positions in emerging-markets telecom stocks, says Dan Kern, one of the fund's managers. "Our short positions performed well," Kern says, "but not enough to offset our long tech holdings." There could be another factor at work: Angeline Ee, one of the two people responsible for the fund's prior-year successes, departed in November and was replaced by a team of managers.
Another way that many long-short funds differ from traditional mutual funds is that they link fees to performance. INVESCO Advantage Fund, for instance, charges a management fee of 1.5% that will be in effect for the first year. After that, the fee can rise to as much as 2.5% or drop to a low of 0.5%, depending on how the fund performs relative to its benchmark, the Russell 3000 index. The standard hedge fund charges a 1% management fee and a 20% cut of the profits.
Despite the similarities, the best-performing long-short mutual fund probably won't ever top the best hedge fund. That's because mutual fund regulations limit leverage to one-third the value of their assets, and short sales may go only as high as 50% of assets. Still, considering that most mutual funds employ no leverage at all, a long-short fund can make a unique addition to most investors' portfolios.