Mutual Funds
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Funds to spice up your portfolio
Hedge funds go mainstream as more fund companies woo retail investors. Warning: Exercise caution.
May 27, 2005: 12:10 PM EDT
By Amanda Cantrell, CNN/Money contributing writer

NEW YORK (CNN/Money) - Does the phrase "hedge fund" make you think of Long Term Capital Management, high leverage, rogue traders making giant and risky bets, and, as of last week, investment fiascoes big enough to move markets?

If so, you're not alone.

Hedge funds, lightly regulated investment pools for wealthy investors, made news again last week when investors worried that at least one hedge fund lost big money after credit-rating agency S&P cut the debt of General Motors and Ford to junk status.

The rumors were strong enough to spark a sell-off on Wall Street, though the mystery hedge fund never surfaced, and the markets went back to business as usual. The rumblings once again cast these secretive investment funds in a negative light.

But the hedge fund industry is out to change its reputation among retail investors. And some firms are even wooing "mom and pop" investors, inviting them to access this once-exclusive millionaire's club for fees much lower than hedge funds typically charge.

So why would an ordinary investor put hard-earned cash into these seemingly risky investment pools? Well for starters, other traditional investment options aren't looking as attractive in today's markets.

Ron Lake, president of Lake Partners, a Greenwich, Conn.-based investment firm, noted his firm runs a portfolio of mutual funds that use hedge fund strategies, Long and Short Strategic Opportunities, that has returned 47.1 percent since January 1999, much better than the S&P 500 over the same period.

Hedge-like funds

Some mutual fund companies are aiming products that mimic hedge funds squarely at retail investors. These products use hedge fund techniques such as "shorting" stocks, or betting share prices will fall, as a "hedge," or way to profit from declines in the stock market.

"Because these are mutual funds, they have some real advantages over hedge funds namely, daily liquidity, more oversight and regulation, and lower fees, because mutual funds cannot charge an incentive fee," said Lake. "The other difference is that mutual funds cannot use the same kind of leverage as hedge funds. So they tend to be a 'kindler, gentler' version of hedge funds for retail investors."

While the minimum investments can be hefty by mutual fund standards, with some requiring investors to park $25,000 right off the bat, they're much lower than the usual hedge fund minimum of $1 million.

Still, some of the products being offered do require investors to be accredited -- meaning a net worth of at least $1 million or a salary of $200,000 a year. Or investors can buy the fund through an intermediary, such as a registered investment adviser investing on their behalf.

These funds include the DB Hedge Strategies fund, a "fund of hedge funds," which consists of a portfolio of investments in underlying hedge funds. For an initial investment of $50,000, a 1.95 percent annual management fee and a 0.25 percent administrative fee, investors can get exposure to a variety of hedge funds.

Mutual fund shop Rydex recently launched its own fund of hedge funds, with a minimum $25,000 investment, and another mutual fund firm, Oppenheimer, also offers a fund of funds with the same minimum in conjunction with Tremont Capital Management, a hedge fund management and consulting firm.

And some funds are "hedge-like" mutual funds that are aimed at retail investors. These include Alternative Investment Partners' "Alpha Hedge Strategies Fund," which can be purchased directly through retail brokers like Ameritrade, Charles Schwab and Fidelity. The minimum investment is $10,000.

There's also the Legg Mason Opportunity fund, the Boston Partners Long/Short fund, and the Hussman Strategic Growth fund, which uses S&P 500 and Russell 2000 put and call options to hedge the portfolio.

Then there's the Quadriga "Superfund."

Quadriga, an Austrian fund management firm, markets the Superfund as a "retail hedge fund" to customers in its home country. While they cannot call themselves a hedge fund in the United States due to Securities and Exchange Commission regulations, the firm is marketing the Superfund to U.S. investors for a minimum of $5,000.

It claims its Austrian version has earned 20 percent a year net of fees for the past eight years.

Safe enough for your portfolio?

Just how safe are these funds for ordinary investors? Judging by Quadriga's abysmal performance this year -- it's down 16 percent through May -- it's clear that some are much more volatile than others.

But others, like the Alpha Hedged Strategies Fund, are steadier performers. So far, that fund is down 0.68 percent through May 25, while the S&P 500 is down about 1.8 percent. Also, compare the S&P's return to that of the Diamond Hill Focus Long/Short Fund, which has risen 3.07 percent through May 25.

"My sense is that these have mainly been created to satisfy investor frustration and in some cases to appeal to those who want the short side," Don Cassidy, a senior research analyst at Lipper, Inc., wrote in an e-mail to CNN/Money. "They are most suited to sophisticated investors with great self discipline and a contrarian streak in their personality."

"That is probably a very small minority of retail investors," he added. "I believe investors should be very careful in deciding on such funds. If one wants to be short, or exposed to commodities, there are lower-cost natural resources funds with probable lower volatility and numerous ETFs that one can go long or short on."

Experts say investors should proceed with caution, taking into account the fund's long-term performance and other factors, such as volatility and expenses.

Also, pay close attention to fees -- many hedge-like funds are more expensive than regular mutual funds, in order to cover higher trading costs. It's also important to look at the fund's volatility. If a fund outperforms other types of funds in your portfolio, pay close attention to how much risk it took to get those returns.

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