PHILADELPHIA — Despite concerns from financial advisers, more mainstream mutual fund companies are spicing up their fund lineups with products that employ strategies long used by hedge funds.
The Vanguard Group Inc. of Malvern, Pa., last month announced plans to reorganize the $21 million Laudus Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund into a new Vanguard fund.
The Laudus fund is advised by
Charles Schwab Investment Management Inc., a unit of The
Charles Schwab Corp. in San Francisco but subadvised by Orinda, Calif.-based AXA Rosenberg Group LLC, which under the reorganization would remain as subadviser.
The reorganization, which is expected to be complete by the end of the year, will mark Vanguard’s first major foray into long/short market-neutral strategies.
Other big-name companies are scrambling to introduce
institutional-style strategies to their funds.
Boston-based
Fidelity Investments in May unveiled three “enhanced index funds.”
The funds employ complicated quantitative strategies to deliver returns that are 1 or 2 percentage points higher than the benchmarks they mirror.
And DWS Scudder, the U.S. retail division of Deutsche Asset Management Inc. of New York, a subsidiary of
Deutsche Bank AG of Frankfurt, Germany, last month rolled out the DWS Alternative Asset Allocation Plus Fund, a fund of funds that employs a variety of alternative-investing strategies.
Advisers are wary
To be sure, financial advisers are leery.
The strategies used by many hedge funds are not exactly risk free. In June, for example, two hedge funds at The Bear Stearns Cos. Inc. in New York plummeted in value after investing in securities linked to low-quality mortgages.
It also doesn’t help that some of the most popular strategies used by hedge funds — such as long-short investing — are barely keeping pace with the market. Year-to-date through Aug. 29, the average long-short fund tracked by Morningstar Inc., of Chicago, had climbed 2.81%, compared with 3.2% for the Standard & Poor’s 500 index.
Last month, the long-short category was one of the worst-performing groups among the 18 domestic-stock categories tracked by Morningstar.
“Prior to last month, there may have been an appetite for these kinds of funds, but at this point, I don’t think I would even touch something like this,” said Jeff Feldman, president of Rochester Financial Services in Pittsford, N.Y.
“I personally, as well as many other advisers, will adhere to the old standards,” he added, referring to traditional mutual funds that take long-only positions in stocks.
It only makes sense, especially since there are additional risks in shorting stocks, said Don Martin, president of Mayflower Capital in Los Altos, Calif. Because they are being asked to do more, there’s a greater possibility that managers will make mistakes, he said.
He feels similarly about mutual funds and exchange traded funds that invest in commodities — another alternative investment that’s a favorite among hedge funds.
Funds that invest in commodities via futures can run into problems, Mr. Martin said.
For example, when the futures markets are in “contango” — that is, when the distant delivery for futures exceeds spot prices — funds that invest in commodities via futures can underperform, he said.
That’s exactly what happened to the United States Oil Fund LP, an ETF-like product from Victoria Bay Asset Management LLC in Alameda, Calif., earlier this year.
It drastically lagged the run-up in oil prices earlier this year, much to the disappointment of its investors.
No one is denying that such products can be complicated.
It’s one of the reasons why Vanguard isn’t targeting retail investors with its new long-short fund, said George U. “Gus” Sauter, chief investment officer for the company.
The fund will require minimum initial investments of $250,000 for Investor Shares and $5 million for Institutional Shares. “The thinking is that it is a sophisticated investment requiring sophisticated knowledge,” Mr. Sauter said.
Critics, however, find that response confusing.
“When Vanguard is trying to tell the retail investor, this is something they should stay away from. I would say institutions need to think about what they are buying,” said Jim Lowell, founder and chairman of The Rankings Service, a Needham, Mass., research service for institutional clients.
Vanguard, however, is offering the fund because it is something institutional investors have asked for, Mr. Sauter said.
“I think it’s a recognition that institutions are looking for a certain type of investment to fill certain needs,” he said.
By making Investor Shares of the fund available, however, there will be some retail investors who will almost certainly find their way into the fund. And while Mr. Sauter may be leery to market such a fund directly to retail investors, others are less so.
DWS Scudder, for example, believes that with the help of the right financial adviser, investors can use mutual funds that use alternative, hedge-fund-like strategies to their advantage, said W. Douglas Beck, a managing director and head of product at DWS Scudder.
Such strategies can be very useful to investors looking for non-
correlated investments, he said.
It’s one of the reasons DWS Scudder is focusing in the area of alternatives, and hopes to develop a reputation as a good provider of such products, Mr. Beck said.
“There is a clear trend towards these kinds of products,” he said.
