Until recently, if high-net-worth
investors wanted to invest in an absolute-return strategy, their options were
limited: either tie up a significant amount of money, usually $1 million or
more, in a hedge fund or bypass this potentially valuable option altogether. Now
they have a new alternative. Mutual fund companies have begun offering a fresh
breed of products that use hedge fund-like strategies but with some of the
advantages of mutual funds, including lower investment minimums.
Fueling these strategies is the increased demand by investors
to diversify away from passive investments. Relative-return products–those
focused on a benchmark, such as the S&P 500 index–traditionally do well
during periods of strong market performance; however, these products usually do
not attempt to manage risk and volatility during difficult times. Investors have
been limited in their choice of products that seek absolute returns.
Hedge funds have been one of the most popular alternatives for
investors looking to reduce overall portfolio risk and volatility, but this
strategy continues to present significant concerns for many. In addition to
their large investment minimums, hedge funds may deter investors because of
their lack of transparency, substantial fees, extended lock-up agreements and
overall complexity.
Facing a sustained low-return environment and lacking viable
opportunities to provide investors with enhanced returns, a number of large
funds, as well as smaller niche investment managers, reexamined the investment
capabilities of mutual funds and created this new class of hybrid mutual fund
that emphasizes positive returns and low correlation to traditional market
indices. Morningstar, which recently adopted a new category for long-short
mutual funds that includes several of these hybrids, reports that there are more
than 50 such funds available to investors, with combined assets of roughly $18
billion.
Absolute-return mutual funds may use investment strategies and
techniques usually associated with hedge funds, such as short selling and
arbitrage strategies, in an attempt to provide hedge fund-like results. As an
example of hedge fund performance, over the past five years, the Credit
Suisse/Tremont Hedge Fund index has had average annual returns of 8.63 percent,
versus 2.36 percent for S&P 500, while providing low correlation and low
volatility relative to the broader markets.
In addition to boosting diversification and seeking to lower
overall portfolio volatility, absolute-return mutual funds may not involve the
same complexity of due diligence as traditional hedge funds. Because these funds
are registered with the SEC, investors enjoy a higher level of transparency and
disclosure. In addition, mutual fund assets are held by an independent custodian
as opposed to money invested in a private placement vehicle.
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