Hedged Mutual Funds: Investment Trends and Business Models

Finadium Research Report

Hedged Mutual Funds: Investment Trends and Business Models

Finadium
December 2010

Regional Focus: US

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This report presents a strategic and statistical look at the US hedged mutual fund industry, including long/short, absolute return and market neutral ’40 Act funds. Our analysis compares these funds to one another and to the ETFs and ETNs that mirror their strategies. Our data are drawn from the filings of 99 US mutual funds and 14 ETF and ETNs, as well as conversations with hedged mutual fund managers and their service providers.

The US hedged mutual fund segment is growing rapidly; assets doubled to over US$50 billion between June 2009 and October 2010. Operators of these funds include large mutual fund complexes seeing a new opportunity, hedge funds looking to repackage their offerings, and registered investment advisors marketing internal strategies to a broader audience. Currently 14 funds have the majority of assets under management, but an additional 85 funds are in operation and most are growing at a steady pace. The market is confusing however, with the names, prospectuses and holdings of funds not always conforming to investor expectations.

Operationally, hedged mutual funds continue to work out the best routes to access cash for margin and securities for short sales. As retail investors already pay higher than average fees to participate in these funds, managers are incented to look for prime brokers and custodians who can meet their needs in a cost effective, operationally efficient way. Having learned important lessons from 130/30 funds in 2007 and 2008, prime brokers and custodians have responded with new service models for these leveraged funds, and are finding that the services they can offer to hedged mutual funds are directly relevant to hedge funds and pension plans as well.

While still a small segment of the overall US mutual fund marketplace, hedged mutual funds are becoming increasingly attractive to retail investors and their financial advisors as either part of an alternative asset portfolio or as a substitute for long-only funds. As retail investors look for more diversification in their portfolios, mutual funds that use long leverage and take short positions will be substantial beneficiaries.

This report provides useful data and detail for asset managers offering hedged mutual funds to the market, institutional investors in these funds, and service providers across custodians, prime brokers and technology firms.

This report is 37 pages with 25 exhibits.

TABLE OF CONTENTS
■ Executive Summary

■ A New Crop of Hedge Funds for the Masses
– Methodology

■ Styles and Leverage Use
– Long/Short and Absolute Return
– Market Neutral
– Leveraged Mutual Funds vs. Long/Short ETFs

■ Are The New Hedged Mutual Funds 130/30s in Disguise?

■ Operations and the Role of Custodians and Prime Brokers
– Custodian Market Share of Hedged Mutual Fund Assets

■ Marketing to Retail Investors
– Returns and Expenses

■ Growth Projections

■ Appendix: League Tables of Hedged Mutual Funds

■ About the Author

■ About Finadium