FINANCIAL TIMES
July 10, 2011
US retail industry embraces alternative strategies
By Michael Shari
A couple of years ago, an irate hedge fund investor marched into the office of Tom Stringfellow, chief investment officer of Frost Investment Advisors, in San Antonio, Texas. The investor announced he was cashing out of a private hedge fund because it had fallen in the stock market crash of 2008 in spite of its “absolute return” strategy. He was still paying exorbitant management fees in spite of the underperformance. The fund managers had refused to disclose which stocks or bonds they had long or short positions in. And they had made him wait helplessly for months before letting him withdraw his money.
It was a familiar litany of complaints. Mr Stringfellow advised him to invest in an emerging breed of mutual funds that are registered with the Securities and Exchange Commission but invest in alternative asset classes, short stocks and generally behave like hedge funds. SEC rules limit their use of leverage and shorting, prevent them from charging performance fees, and let investors withdraw without penalty.
“People are saying, ‘if I can get a quality manager with better liquidity and better terms, why wouldn’t I do that?’” says Paul Heathwood, director of intermediary sales at Robeco Investment Management in New York.
In a trend that Mr Stringfellow calls “the retailisation of alternative strategies,” traditional asset management groups like JP Morgan and Nuveen, hedge fund management firms like AQR and Goldman Sachs, and even boutiques like Frost, have registered 397 such funds under the Investment Company Act of 1940 as of April. At least 149 of them have been launched since 2009, the year after the crash, while another 38 that have been registered are not yet operating, according to Strategic Insight, a research firm in New York.
This fast-moving trend has the potential to reshape the entire money management industry by blurring the lines between long-only mutual funds for the smallest of investors and alterative investment strategies that were once the province of wealthy individuals.
Kevin Quirk, a partner at investment management consultancy Casey, Quirk & Associates, expects this convergence to work to the advantage of larger hedge fund managers that have a large enough client-facing and distribution infrastructure to treat their clients just like mutual fund managers treat theirs. He also sees it favouring large, traditional money managers that already manage a combination of private hedge funds and hedge funds in ’40 Act wrappers for the retail market.
In five or 10 years, Mr Quirk predicts, the hedge fund industry will be more modern, commercial, transparent and “much, much bigger” than the $2,020bn in assets that all private hedge funds managed in April, according to Hedge Fund Research.
The hedge fund firms that several analysts see as most likely to prevail are managers of global macro strategies, which are regarded as the most compatible with the ’40 Act structure. They include Bridgewater Associates and Och-Ziff Capital Management Group, event-driven firms Canyon Partners and Fir Tree Partners, credit manager Tricadia Capital, emerging market manager Artha Capital Management, and European activist manager Cevian Capital.
Some of the more successful funds are clones of private hedge funds that have strong track records. One of the oldest is the $478m Robeco Long-Short Equity Fund (BPLEX), which has delivered a 10.47 per cent annualised return over the past 10 years. In 2008, the year the Standard & Poor’s 500 Index fell 37 per cent, the Robeco fund fell only 21 per cent.
The Robeco fund has an expense ratio of 2.75 per cent, which is high by the standards of a mutual fund but low by those of a hedge fund.
It is one of the 397 SEC-registered funds that have received $67bn in net inflow during the past 12 months in a relatively small universe of $353bn in assets, according to Strategic Insight.
Financial advisers say they are using these funds for diversification from retail equity mutual funds now that the yield on 10-year Treasuries has fallen to 3.22 per cent and the Standard & Poor’s 500 Index is up a mere 7.43 per cent for the year to date (to July 5).
“Retailisation” is growing even faster in Europe, where hedge funds in Ucits III wrappers are allowed to charge performance fees in addition to management fees.
“This difference, and the broader international appeal of Ucits, has drawn more European hedge fund managers to launch Ucits products versus the number of US hedge funds managers who have launched ’40 Act funds,” says Loren Fox, an analyst at Strategic Insight.
To be sure, no one expects private hedge funds to fade away.
They sucked up $32.54bn in net inflow during the first three months of this year – nearly three times the $55.46bn in net inflow for all of 2010.
But they are working harder to satisfy clients’ demands for better relative returns and more disclosure.
“There is growing transparency. The days when the manager said, ‘Don’t call me, I will send you your returns at the end of the year,’ that does not exist any more,” says Paul Roth, a partner at Schulte Roth & Zabel International, a New York law firm with more than 1,000 hedge fund clients.