Firms Package Hedge Funds In Mutual-Fund Clothing
August 13, 1999
--------------------------------------------------------------------------------
Firms Package Hedge Funds
In Mutual-Fund Clothing
By PATRICK MCGEEHAN
Staff Reporter of THE WALL STREET JOURNAL
Mutual funds and hedge funds are supposed to be two very different breeds of cat. But, lately, there is a lot of crossbreeding going on.
More and more, Wall Street firms are using mutual-fund formats to expand the market for what essentially are hedge funds, investment pools that traditionally have been open only to small groups of wealthy investors. These hybrid funds are targeting only a segment of the investing public, but they're aiming to attract thousands of investors, not just the few hundred that an individual hedge fund is limited to.
Like standard hedge funds, these hybrid funds still require high minimum investments and charge high fees, and most keep tight controls on withdrawals. Most also are free to use a variety of risky techniques to pad their returns, such as investing with borrowed money and selling borrowed securities, also known as selling short. Although these funds generally are variants of a closed-end mutual fund, they don't trade on any stock exchange.
"Fund companies are making more creative use" of the federal regulations that govern mutual funds, says Janet Olsen, a lawyer in Chicago with Bell, Boyd & Lloyd. "We're way past the plain-vanilla equity fund. People are doing all sorts of things."
----------------------------------------------------------------
Hidden Hedge Funds More Wall Street firms are using mutual-fund formats to sell what essentially are versions of investment pools once open only to sophisticated and wealthy investors:
Fund (Marketer) Getting in Annual fees Getting out
Multi-Strategy Mkt-Neutral
(Salomon Smith Barney) $10,000 2% of assets Redemption like a mutual fund
Seligman New Tech.
(J. & W. Seligman) $10,000 3% Quarterly buyback of up to 5% of assets
PW Technology Partners
(PaineWebber) $250,000 1%-2% and 15%-20% of profits Periodic redemption
Whistler Fund
(Oppenheimer) $150,000 1% and 10% of profits Periodic redemption
Troon Partners
(Oppenheimer) $150,000 1% and 20% of profits Periodic redemption
Source: Company reports
------------
At least four major investment firms this year have registered with the Securities and Exchange Commission to sell these more exotic varieties of mutual funds. Among them are such well-known Wall Street names as Citigroup's Salomon Smith Barney securities-brokerage unit and PaineWebber Group.
Some on Wall Street see the creation of these hybrid funds as a step toward democratizing the world of investments by granting more people access to highly regarded, private money managers. Critics, however, worry that they are too risky to be suitable investments even for rich people.
The spread of these funds shows that, deep into a longstanding bull market, more people are willing to take the sorts of extraordinary investment risks -- with hopes of getting extraordinary rewards -- that had been reserved for the wealthiest investors. It also illustrates how quickly investors have shed their fears of hedge funds in the wake of the near collapse of Long Term Capital Management less than a year ago.
For example, PaineWebber recently launched a mutual fund that invests in a handful of technology-oriented hedge funds, just months after Long Term Capital's problems led the brokerage firm to shelve another mutual fund of hedge funds it was trying to start. Last fall, investors simply wouldn't listen to a pitch about the benefits of hedge-fund investing, say people familiar with that earlier planned mutual fund.
Now, Wall Street firms are taking the hedge-fund story back to the investing public. Salomon Smith Barney in May created a mutual fund that is dividing its assets among three outside hedge-fund operations. Among the techniques the managers will employ: arbitrage involving such things as stocks of merger-and-acquisition candidates and debt securities that convert into stock. Arbitragers attempt to exploit pricing discrepancies.
That fund has many of the characteristics of a standard mutual fund: Investors can get in for as little as $10,000, can track the value of their shares daily and can sell their shares back to the company at any time they choose. The fund is included in the firm's TRAK fund program that charges customers a flat annual fee of 1.5% of assets.
Salomon Smith Barney sees its MultiStrategy Market-Neutral Fund, which carries annual fees of about 2% of assets on top of the TRAK program costs, as a more conservative alternative to stocks or stock funds. Overall, the fund's goal is to limit exposure to swings in the stock market.
Salomon Smith Barney's customers "wanted a product that is a hedge-fund vehicle that uses some of these strategies that people have been reading about in the paper," says Lee Pease, director of portfolio advisory services in the firm's Consulting Group unit. "We believe the most conservative way to offer the product is in a mutual-fund format," he said, referring, among other things, to investors' ability to redeem their shares of the Multi-Strategy Market-Neutral mutual fund on a daily basis, while most hedge funds sharply restrict such redemptions.
Mr. Pease says the firm is considering creating two more-aggressive mutual funds that will use other investing strategies associated with hedge funds. The trick, he says, is that hedge-fund managers who employ riskier strategies tend to charge higher fees and want to invest in less-liquid securities, making it difficult to fit them into a standard low-fee, open-end mutual-fund format. The average expense ratio for all stock funds is about 1.66%, according to fund-tracker Morningstar Inc.
A desire to invest more in companies before they ever go public is what drove J. & W. Seligman & Co. to launch an unusual fund this summer that will be managed by two of its in-house mutual-fund managers but could be even more difficult to get out of than a hedge fund. Investors can get into the Seligman New Technologies fund, managed by Paul Wick and Storm Boswick, for $10,000 but their chances to sell will be limited to quarterly offers to buy back up to 5% of the shares.
To attract technology investors who want to boost their returns, PaineWebber turned to outside hedge funds. Its new fund, PW Technology Partners, is spreading its assets among a few outside hedge funds that specialize in the technology sector, including Pequot Technology Perennial Fund and Spinnaker Technology Fund. Pequot, which annually keeps 2% of the money allocated to it and 20% of the profits it earns, doubled its investors' money in 1998, according to regulatory filings for PW Technology Partners.
PaineWebber's fund will charge a blend of the fees charged by the hedge-fund managers.
"A lot of investors are looking for something that will offer them a greater return than mutual funds," says Barry Barbash, a partner with the law firm Shearman & Sterling in Washington and a former SEC official. "But an investor who goes into one of these needs to know that it's riskier than a mutual fund, could charge higher fees than a mutual fund and could have greater amounts of leverage than a mutual fund."
Mr. Barbash attributes the growing number of these hybrid funds to that appetite for bigger returns, rather than any changes in regulations or regulatory attitudes. But others in the fund industry say one catalyst was the 1997 change in securities laws that loosened restrictions on how much income mutual funds could get from shorting stocks. That change, which invited funds to take greater risks, got fund-company executives thinking about other ways of goosing the performance of mutual funds, these industry experts say.
PaineWebber's fund is the brainchild of Mitchell Tanzman and Greg Brousseau, who came to the firm early last year from CIBC Oppenheimer. At Oppenheimer, they were involved in the launch of some of the earlier hybrid funds, which essentially are hedge funds in disguise.
Oppenheimer recently launched its fifth hybrid fund, which, like PaineWebber's fund, spreads its assets among several outside hedge-fund managers. That fund, the Whistler Fund, requires an investment of $150,000 and annually charges investors 1% of their assets and 10% of net profits.
Some fund-industry experts see these hybrid funds as boomtime phenomena that will fizzle if and when financial markets take a steep downturn. One of the pioneers of the format, the Panther Partners Fund launched by hedge-fund firm Tiger Management several years ago, dissolved in 1997 when its managers found mutual-fund investing restrictions to be too confining for their tastes. That fund was folded into the firm's Tiger hedge fund, and the firm has stuck to private funds since then.
* * *
Money-Market Assets Increase
Money-market assets rose $8.64 billion in the week ended Wednesday to $1.489 trillion from a revised $1.48 trillion, the Investment Company Institute said.
Assets of the 930 retail-class shares increased $2.66 billion, to $887.9 billion, the trade group said. Among retail-class shares, assets of the 583 taxable shares climbed $3.03 billion, to $736.62 billion, while assets of the 347 tax-exempt shares declined $368.4 million, to $151.28 billion.
Assets of the 792 institutional-class shares increased $5.97 billion, to $600.93 billion. Among institutional-class shares, assets of the 619 taxable-shares increased $6.55 billion, to $552.49 billion. Assets of the 173 tax-exempt shares fell $575.4 million to $48.44 billion.
--------------------------------------------------------------------------------
Write to Patrick McGeehan at patrick.mcgeehan@wsj.com
Copyright © 1999 Dow Jones & Company, Inc. All Rights Reserved. |
