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.