From the October 2006 issue of Wealth Manager Web • Subscribe!

A Higher Standard

Geronimo Financial is a small money manager with a big idea: Tear down the barriers for hedge fund investing. Not just a little, but all the way. A tall order, to be sure, but one that Geronimo claims it offers with a recently launched mutual fund, the Geronimo Multi-Strategy Fund (GeronimoFunds.com).

Bringing hedge funds to the masses is an idea that's been around for a while. But the results have been mixed when it comes to delivering the hedge fund space writ large in one portfolio that's both affordable and representative of the alternative funds world. Taking a fresh shot at the challenge is the four-year-old Geronimo Financial, which specializes in privately managed absolute-return investment strategies.

The Denver firm recently expanded into the world of mutual funds, which is good news for investors who are looking for an expansive definition of hedge funds in one package. Geronimo Multi-Strategy is a noteworthy addition to the small but growing niche of alternative investment mutual funds. Indeed, Geronimo Multi-Strategy sets a new standard for advancing the concept of democratizing hedge fund investments. The fund's most impressive feature is its diversification across eight broad hedge fund strategies, each represented by dozens of existing hedge funds chosen by HFR Inc. for its HFRX Equal Weighted Strategies Index, an investable index-platform previously available only to institutional investors. The fund also features:

o Low minimum investment of $1,000

o No net-worth accreditation hurdle for investors

o Daily liquidity and pricing

o Performance-based fee structure

o Daily monitoring and analysis by HFR of the managers in the index

It's too soon to pass judgment on a fund with less than a year of history, but Geronimo Multi-Strategy is clearly an intriguing newcomer that could ultimately set a new standard for publicly traded alternative investments. Indeed, others have tried to make multi-strategy hedge fund investing more affordable and accessible, but the growing pains have been considerable. For one notable example of what has gone wrong, stir the ashes of the now-defunct products tied to the S&P Hedge Fund Index. In June, Standard & Poor's stopped publishing the benchmark--a victim of the blowback from Refco, the derivatives broker that collapsed last year. As a result, products benchmarked to the S&P Hedge Fund Index have been forced into early retirement, including the Rydex Sphinx Fund, a publicly registered fund that succumbed.

Even among the new generation of hedge fund products that are currently available, there's plenty of grumbling about portfolio design. In some cases, critics say that the manager choices are unimpressive, or that portfolios are relatively undiversified. In other funds, they find liquidity to be limited, or that investors must be relatively wealthy in order to buy shares.

Still, there are choices to consider, and they're growing in number and sophistication. Rydex, for instance, rolled over the remaining Sphinx assets into the firm's Absolute Return mutual fund, a new quantitatively managed portfolio that replicates a mix of hedge fund strategies with derivatives and various trading techniques. In fact, there's a lengthening list of mutual funds focused on one or more hedge fund strategies, such as long/short and market-neutral. According to Morningstar, 39 long/short mutual funds were plying the investment waters at mid-point this year.

It would appear that Geronimo Multi-Strategy is just one more addition to an already established field. But while launching a "long/short" mutual fund is old hat these days, a closer look at the Geronimo portfolio suggests that it's a bit different after all. While it remains to be seen if Geronimo satisfies as an investment in the long run, it is a new yardstick for bringing multiple hedge fund strategies to the masses in a single fund.

The fund's architect is David Prokupek, CEO and CIO of Geronimo Financial, which he founded in 2002. Most of the $350 million under management at Geronimo Financial resides in privately managed accounts, but Prokupek embraced a wider audience in January when he launched three mutual funds: Geronimo Sector Opportunity, a long/short fund; Geronimo Option & Income, a market-neutral strategy; and Geronimo Multi-Strategy, which has the broadest scope of the three.

Geronimo Multi-Strategy is essentially an enhanced hedge fund index, with HFRX Equal Weighted Strategies Index (HFRX) serving as the index and Prokupek's management delivering any enhancement. Prokupek, who was formerly president of the capital markets group at investment bank Tucker Anthony Sutro, recognizes the challenge of trying to second guess a broad-based multi-strategy hedge fund index like HFRX. In deference to the risk, Geronimo Multi-Strategy's returns will be primarily driven by HFRX over time, he says. His attempts to enhance the benchmark's returns will play a secondary role with manager and strategy selection. For example, Prokupek explains that he may overweight certain managers, or underweight a strategy, relative to the HFRX mix. Prokupek can also adjust the fund's allocation to HFRX overall, depending on his outlook for hedge fund strategies.

The overall goal is producing so-called absolute returns by tapping into the broad landscape of hedge fund strategies and tracking or exceeding HRFX's returns. Historically, the multi-hedge fund universe has produced returns of roughly LIBOR plus 300 to 500 basis points, he says.

With so much riding on HFRX, the first order of business for assessing Geronimo Multi-Strategy is reviewing its benchmark, which equally weights among eight HFRX sub-indices, each targeting a particular hedge fund strategy, such as convertible arbitrage, distressed securities and relative value (see hedgefundresearch.com for details). In all, some 80 managers are included in the HFRX index.

The ability to access HFRX's manager lineup is a breakthrough for a mutual fund, says Prokupek. Although there are competing mutual funds that hold multiple hedge funds, Geronimo--courtesy of HFRX--distinguishes itself by exposing assets to the performance results born of dozens of managers. By contrast, Alpha Multi Strategies--a competing mutual fund--recently was using nine hedge fund managers as subadvisors. There's nothing wrong with that, Prokupek says, but it's a different, more narrowly focused approach, and shouldn't be confused with Geronimo Multi-Strategy's grander ambitions.

In addition to quantity, Prokupek emphasizes the quality of the hedge fund managers in the HFRX index. The Chicago-based HFR is really two companies: HFR Inc. is the database and research division; HFR Asset Management offers an investable hedge fund index platform to institutional investors. Geronimo's partnership with HFR allows the Multi-Strategy Fund to tap into the returns streams from dozens of hedge funds in an investable-index platform designed for institutional investors.

Opening a portion of HFR's platform to anyone, for a nominal sum, is a considerable achievement in the annals of hedge fund investing, says Bill Santos, senior managing director of business development for HFR Asset Management. "The fact that you now have the ability to access these 80 or so institutional-quality hedge fund managers in a mutual fund structure, with daily liquidity, with a $1,000 minimum, and no accreditation is big news," he adds.

However, the transmission of HFRX's hedge fund returns to Geronimo Multi-Strategy is a bit circuitous, coming by way of swaps, or privately negotiated derivatives contracts. Geronimo Multi-Strategy doesn't invest in the HFRX funds directly. Ownership of so many hedge funds would be problematic for a mutual fund for a number of reasons, including liquidity constraints and calculation of net asset values on a daily basis.

Geronimo gets around the obstacles with an innovative back-office strategy of tapping into HFR's platform through the magic of financial engineering. The fund receives the associated performance of the index by way of total-return swaps. The bottom line: Several financial firms contract to deliver the related gains or losses to Geronimo's fund. As of this past May 31, for example, 39 percent of Geronimo Multi-Strategy's net assets were in swaps issued by investment banks IXIS Corporate & Investment and Barclays Capital.

By mutual fund standards, Geronimo Multi-Strategy doesn't come cheap, with a gross expense ratio that can rise to as much as 3 percent for I class shares available to wealth managers. That looks pricey if you consider that most of the domestic stock funds in Morningstar's database charge less than 2 percent. Then again, Geronimo's expense ratio is slightly below the 3.24 percent average for Morningstar's long/short fund category. And by hedge fund standards, where 2-and-20 pricing is common (2 percent of assets and 20 percent of any profits), Geronimo's fees are a bargain.

Meanwhile, fans of incentive-based pricing will find reason to cheer Geronimo Multi-Strategy's dynamic fee system, which is one of the more ambitious in the mutual fund world. The fund's basic management fee is 1.25 percent, but that can fluctuate, based on whether the fund's returns exceed the Merrill Lynch Three-Month Treasury Bill Index over the preceding 12 months. The management fee will stay at 1.25 percent as long as the fund's performance is within a band of plus or minus 200 basis points of the Merrill Lynch T-Bill.

If performance rises above that 200-basis-point band, the fee increases; if performance drops below the band, the fee drops. Overall, the management fee can range from 0.25 percent to 2.25 percent, and so the gross expense ratio can vary from 1.0 percent to 3.0 percent for the I class of shares after adding the fixed 0.75 percent "other expenses" component.

For investors who are convinced that owning a wide sampling of hedge fund strategies is a worthwhile addition to an asset allocation strategy, Geronimo Multi-Strategy promises to be a favorite. The larger question is whether hedge funds will live up to the hype in the long run and materially improve the risk-reward profile of a traditional stock/bond/cash portfolio.

All the innovations in the world don't change the fact that it's too early to make definitive conclusions about hedge fund performance generally. The products have precious little performance history for making the kind of sweeping judgments about the past such as those dispensed in the name of equity and fixed-income indices. Financial engineering continues to impress, as Geronimo Multi-Strategy illustrates. But some questions about portfolio strategy can only be answered with time. Even though it's becoming easier to own hedge funds, the jury is still out on the long-term merits of hedge funds in context with other asset classes.

James Picerno (jpicerno@highlinemedia.com) is senior writer at Wealth Manager.

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