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| Risk & Reward |
An Alternate Route Through the Hedge Fund Maze
Laurence Neville
12/01/2003
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The inherent problems with direct investing in hedge funds are well documented. Picking winning portfolio managers is as difficult—and likely—as winning an on-the-nose bet at Belmont, and the most successful funds often turn hopeful investors away at the gate. These problems have spurred the popularity of funds of funds.
But funds of funds are expensive—and their cost structure can do more than nibble at the edges of returns. Typically, a high net-worth investor will pay under 1 percent for advice on which funds of funds to embrace. A funds of funds manager may pile on an additional 2.5 percent. Individual fund managers then extract, on average, a 2 percent fixed fee (based on assets) and 20 percent performance fee (based on returns).
PICKING WINNERS
Successful hedge fund managers,
like winning Thoroughbreds, are exceedingly rare. But you can’t win
at the races by betting the whole field. Why try it with your investments? Diversification reduces the chance you will bet it all on a nag. |
The index-linked products seek to dramatically reduce these costs, leaving more returns in investors’ pockets. For example, the Rydex SPhinX fund, from Rydex, a Rockville, Md., mutual fund company, is based on the S&P Hedge Fund Index. Here the gates are virtually wide open: The ante is a mere $25,000 (compared with the $5 million minimum typical of hedge funds), and to qualify, investors need only demonstrate a net worth of $1 million and an annual income of more than $200,000. Its fees are more like those of a mutual fund than those of a hedge fund or fund of funds: Rydex SPhinX charges only 1.95 percent of assets.
Backers also say the index-linked products, such as those available in the stock markets, give broad exposure to the sector, eliminating the need to "pick winners." "An index of hedge funds comes down to the general point of any index product," says Neil Aslin, president of Chicago-based Peregrine Financial, a trading and investment firm. "Do you want to invest in the forest or specific trees? The data shows that with any asset class, a strategy of investing in the forest rather than trying to pick the best performers works best."
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