What Works For Hedge Funds…

Might work for copycats not subject to mutual fund rules. That's the plan, anyway.

The hedge fund boom has given rise to a host of mutual funds and closed-end funds that mimic hedge fund strategies. These wannabe funds, however, will always be just that. Under the law that governs them but not hedge funds, they can't borrow an amount exceeding one-third of their assets. That limits their ability to sell short stocks they think are going to fall or leverage up on those they think are going to rally.

Now, there's another way for individuals who may covet hedge-fund-like returns and are willing to take the risk: buying shares in companies that invest like hedge funds.

Greenlight Capital Re (GLRE ), which went public on May 24, is one. As a reinsurance company, it sells insurance policies to other insurers, collects premiums, and invests the proceeds. Typical reinsurers invest in a staid portfolio of bonds, but not Greenlight. Its money is managed by DME Advisors, the $4 billion New York hedge fund firm run by David Einhorn, a superstar manager known for finding deeply undervalued stocks and highly overvalued stocks. Einhorn's own hedge fund, which opened in 1996, has earned an average of 29% a year.

To run the Greenlight account, Einhorn uses both long and short strategies in equities and corporate bonds. He also uses futures and options that can magnify its gains--or losses. The portfolio beat the Standard & Poor's 500-stock index handily in 2005 and 2006. The first quarter of 2007 was not good. The portfolio lost 4% while the S&P rose almost 1%, but it bounced back in April with a 3% gain. As of Mar. 31, the last quarterly report, Greenlight had $250 million in long positions and $141 million sold short. Of course, Greenlight is still an insurer, and losses on policies could eat into investment gains.

Greenlight's leverage looks tame compared with that of Cypress Sharpridge Investments, a real estate invesment trust that is expected to go public this summer. The company is jointly managed by former Fidelity Investments bond fund manager Kevin Grant, who now runs a mortgage-backed securities hedge fund, and Cypress Group, a leveraged buyout firm.

For now, the new outfit will invest in prime residential mortgage-backed securities, collateralized debt obligations, and other asset-backed securities. Some mutual funds do that, too, but Cypress Sharpridge will be doing it on a bigger scale, pumping up its portfolio by borrowing from 10 to as much as 14 times the value of its assets. The idea is to make small trading gains in great number.

It's yet to be shown that these sorts of companies can produce hedge-fund-style results. Investing in them should be done gingerly.

By Aaron Pressman

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