It’s a fair question: Why would a hedge fund manager trade the relative investment and operational freedom — not to mention the potential fee income — of that investment format for the constraints of a ’40 Act mutual fund?
There are numerous differences between the formats to consider. Mutual funds must limit their investments in illiquid securities and cannot invest more than 25 percent of a fund’s assets in a single issue, unless the fund’s investment policy allows concentration. Leverage is capped; the fund must hire independent directors and use a third-party custodian.
Hedge funds use two methods to enter the mutual funds business. One is to launch a new mutual fund and hire a hedge fund manager to replicate his or her strategy within the mutual fund.
The other approach is to convert an existing hedge fund. This involves setting up the organization and redeeming limited partnership interests for shares in the new fund (or cashing out partners who don’t want to continue with the new fund).
Hedge funds operating investment strategies in line with the ’40 Act’s restrictions are better suited for conversion. Examples include currency and managed futures, global macro, long/short equity and market neutral.
According to Victor Viner, founder and chief investment officer of V2 Capital LLC in Glenview, Illinois, converting his firm’s hedge fund to a ’40 Act Fund on Oct. 31, 2014, was “pretty much an easy business decision.”
The conversion moved $240 million of assets, making it the largest hedged equity mutual fund launch of the year, according to the firm.
Here’s why Viner made the switch.
One: Broader appeal
The hedge fund had a $5 million minimum and the V2 Hedged Equity Fund (VVHIX) has a $1,000 minimum: That lower minimum exposes the fund to a much broader market of potential investors, even though the firm gives up its chance to earn performance fees.
The fund follows a long/short strategy that combines a long concentrated portfolio of 30 to 50 U.S. equities with a short portfolio of customized S&P 500 options.
Viner says the objective is to “generate alpha on both sides and to keep to a net exposure that is between 20 and 80 and averages in the low 50s.”