June 25, 2010

At Morningstar Conference, Asness Speaks on Alternative Strategies

Wealth Manager's exclusive interview with Clifford Asness on using hedge fund strategies with mutual fund transparency

A big trend in hedge fund investing is the creation of mutual funds, under the Investment Company Act of 1940, that use hedge fund strategies, according to Clifford Asness, a PhD and managing and founding principal at AQR Capital Management.

Wealth Managers may want to use alternatives such as hedge funds or their '40-Act mutual fund counterparts to provide less correlative additions to clients' portfolios, to add same or better returns overall with a lower risk profile. The '40 Act funds are, of course, less costly at 150 basis points than their hedge fund counterparts, which can cost 1% (management) plus 10% (of gains) for "hedge fund beta" exposure, or 2% plus 20% for "hedge fund alpha," Asness explains.

Asness sat down for an exclusive interview with WealthManagerWeb.com Editor in Chief Kate McBride on June 24 at the Morningstar Conference. Using alternative or hedge fund strategies in mutual funds can be interesting for wealth managers because regulation of mutual funds provides daily pricing and liquidity, lower cost and less leverage (there's a cap on leverage in '40 Act funds whereas in hedge funds you might have 3:1 leverage), he notes.

Not all hedge fund strategies are portable into '40-Act mutual funds, but his firm has two that use hedge fund strategies. The Diversified Arbitrage Fund (ADANX for the "N" shares), is benchmarked against the Merrill Lynch 3 Month Treasury Bill Index, and uses merger arbitrage and convertible arbitrage as well as other forms of arbitrage and seeks "long-term absolute positive returns," according to the firm's Web site.

In merger arbitrage, they "take [a] long position in the target company and a short position in the acquirer (stock only deal)." There aren't as many mergers being done in the current climate, Asness says, so there is less diversification in the number of deals available. They would do more of this kind of arbitrage if more deals were available. In fact, he told the crowd at his presentation, they'd prefer to do "50 deals rather than 10" from a diversification perspective. He says this kind of arbitrage has been "a good strategy for the last 50 years."

Convertible arbitrage is more prevalent right now, where they buy convertible bonds, which are often cheaper than the sum of their parts if you look at the convertible versus the corporate bond plus call option that would be its equivalent. They then mitigate the interest rate, price and other risks, and "if that bond is cheap, you get paid," over time.

Depending on the share class, expenses are capped at 1.20% (institutional share class at a $1 million minimum) or 1.50% for "N" shares at a $5,000 minimum investment.

The other AQR '40Act mutual fund that uses hedge fund strategies is the Managed Futures Strategy Fund, (AQMNX for the "N" shares), seeking "positive long-term absolute returns." Benchmarked against the Merrill Lynch 3 Month Treasury Bill Index, AQR invests in futures and "futures-related instruments," per their Web site, and may go long or short "equity, fixed income, currency and commodity instruments."

A University of Chicago PhD in finance gives Asness a free markets slant, but he told Wealth Manager it's "pretty clear" that when markets don't work it's a "blow to everyone." That said, he'd rather see no new regulation even though he acknowledges there will be, so for what new regulation there is, what he "dislikes least" is to see "clear rules." For example, you "can't lever more than X," adding that "the broad outlines are not as good."

What disturbs him about re-regulation the most is "political--open end power [given to] the government." When things go wrong, "who gets called systemic and gets taken over and who does not?" Then, he says, you get political "cronyism" and so perhaps the company that some Senator knows of, maybe met the leader of, may have received a donation from, gets saved when another firm that's less well-known to those in government who are making the decisions on 'who is systemic,' topples.

Asness took a stand on the part of re-regulation backing extension of the fiduciary standard for brokers that provide advice to retail investors, when he signed the Fiduciary Statement with other American leaders and Nobel Laureates in March.

On June 24, the House-Senate conference to reconcile their respective bills for financial reforms put forth final language regarding this issue, calling for a six-month study of whether brokers should have to put clients' interests first, and giving the SEC authority to write rules that would direct them to do so if the study calls for that. See "In Reform Bill, Senate and House Reach Deal on Fiduciary."

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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