Tired of the same boring mutual funds? Want some hedge fund action but don't have the $5 million minimum initial investment? Now there is a product for you - a mutual fund of hedge funds called the Blackstone Alternative Multi-Manager Fund. Among others, here are the managers to whom your capital would be allocated.
Two Sigma Advisers
Cerberus Sub-Advisory
Credit Suisse Hedging-Griffo Servios Internacionais
HealthCor Management
Caspian Capital
Boussard and Gavaudan Asset Management
Wellington Management
Good Hill Partners
BTG Pactual Asset Management
Chatham Asset Management
Nephila Capital
And just like in a typical mutual fund you get daily liquidity, except for those pesky early redemption fees. As far as disclosure, Blackstone doesn't want the world to know what fee split arrangement it has with these hedge fund managers (sub-advisors) and will only disclose the aggregate fee.
From the SEC filing: - Applicants also request an order exempting the Subadvised Series from certain
disclosure obligations that may require each Subadvised Series to disclose fees paid by the Advisor
to each Sub-Advisor.
The portfolio is a mix of strategies including distressed credit, black box equity investing, long/short credit, various emerging markets, structured products, etc. It's all the stuff that retail investors wanted to know about but were afraid to ask.
Now that institutional investors are not stepping up to hedge fund investing the way they used to, it's time to tap the retail universe.
2012 was another rough year for equity mutual funds business. In spite of relatively strong stock market performance, retail investors continued to pull their money out. This trend has been in place for quite some time (see discussion), but has accelerated this year. The outflows from US equity mutual funds were roughly $154bn this year.
In spite of poor performance of a number of high profile IPOs this year (won't name any names here), the demand for new issue equity in the US seems to be quite resilient. In fact the total IPO volume this year is the highest since the burst of the tech bubble.
Source: The Leuthold Group
Furthermore, if one includes the secondary stock issuance (vs. just the initial offerings), the amount of new paper hitting the market is at an all-time record this year.
IPOs plus "secondary equity financings
(follow-on offerings from existing public
companies), as well as secondary distributions
(where proceeds go to the selling
shareholders)". (Source: The Leuthold Group)
Who is buying all these shares? Except for a couple of high profile cases, individual investors don't seem to be involved on a large scale. In fact on a net basis it certainly doesn't seem to be coming from mutual funds, as investors continue to pull record amounts.
Source: The Leuthold Group
The funding for new shares seems to be coming from institutions (as well as institutional funds they invest in) that are pushed to the limit by low interest rates. Pensions and insurance firms seem to be forced to move up the risk ladder in order to meet their obligations and, as a consequence, the primary equity market may be the beneficiary.
The trend started in early 2009. Net flows into fixed income mutual funds began to rise, while equity funds stayed flat. The trend continues through today, although equity ETFs have fared better than mutual funds (see discussion). But even within the ETF universe, flows into fixed income accelerated while equity ETFs grew quite gradually if at all.
Shares outstanding for SPY (S&P500 ETF) vs LQD (investment grade bond ETF) (Bloomberg).
Given that the corporate bond market is smaller and less liquid than the equity market, that imbalance in growth of cumulative flows has driven yields/spreads to historical lows. Now some analysts are asking if corporate credit is overpriced relative to equities. One way to assess this is by looking at corporate bond yields vs. equity dividend yields.
The spread between the two has collapsed recently. One gets almost the same income holding corporate bonds as buying the S&P500 stocks. Is this the "new normal" according to PIMCO? Has the "worship of stocks" turned into the "reverence for bonds" (which is of course what Bill Gross wants)? Or are we simply looking at a market dislocation?
Here is the latest data from DB on fund flows for the major asset classes:
Equity mutual funds are continuing to lose ground to ETFs. The US domestic equity mutual funds have lost some $100bn since Jan of 2009, while equity ETFs are up around $50bn during this period.
Source: Deutsche Bank
But the equity asset class as a whole is losing AUM. Some of this capital is of course flowing into fixed income funds. Investment grade corporate bond mutual funds and ETFs have gained $131bn ($42bn into ETFs and $89bn into mutual funds) for the same period, while HY funds picked up $48bn ($20bn into ETFs and $28bn into mutual funds). Given the demographic changes in the US that favor fixed income as well as the loss of confidence in equity mutual funds, this trend is expected to continue.
Stock pickers had a rough year in 2011. For example the Fidelity Magellan Fund underperformed the S&P500 by close to 14%. And Fidelity is not alone.
Investor's Business Daily: Most mutual fund managers underperformed the market [in 2011], and many very badly. Morningstar data show less than a third (29%) of the 21,000 mutual funds it tracks beat their benchmarks. By contrast in 2009, when the bull market started, more than half (52%) of all funds did so.
What could be the reason for this trend? The answer is not straight forward. Some suggest that mutual fund fees cause the underperfomance and are the only thing standing between stock pickers and index funds. But if that is the explanation, why would a fund like Magellan underperform by so much - it couldn't just be their fees. The answer comes down to beta of the stocks they pick. Mutual funds know that in order to overcome their high fee hurdle, they need high beta equities that will beat the index in a rally in spite of the high fees.
2011 was a year of extreme uncertainty and investors dumped high beta stocks causing many to underperform.
But what happened to achieving superior performance with stock selection? That has been quite difficult to accomplish these days because of high correlations among stocks. In fact correlations have been close their 30-year maximum of 1986.
S&P100 Correlation (Source: Citigroup)
With correlations this high, the key differentiator among individual stocks is beta. Pick a low beta stock and risk underperforming the index in a rally. With high fees on top of that underperformance any manager will get investors' attention pretty quickly - negative attention that is. Pick high beta stocks and risk underperforming in a market like we had in 2011. Pick a portfolio of stocks with an average beta of one and get an index-like return because of the high correlation we've had. But with index-like returns how do you justify the fees? Stock pickers are in a no-win situation. And that is one of the reasons the mutual fund industry has been under considerable pressure these days.
The mutual fund industry has been taking it on the chin lately. Investors are becoming increasingly disillusioned with the product. Reasons vary, but most point to years of poor performance coupled with downside risks that are higher than even the downside risks of hedge funds. In late 2008 the loss in many equity mutual funds was double that of an average hedge hedge fund. As an example the chart below compares the Fidelity Contrafund (one of the largest actively managed equity funds in the world) with the CS Hedge Fund Index in 2008. Many other equity mutual funds performed in a similar fashion.
Credit Suisse Hedge Fund Index versus Fidelity Contra Fund (Bloomberg)
Another issue that generated dissatisfaction in mutual funds is the inherent conflict of interest in the industry.
NYT: The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. In general, these companies spend lavishly on marketing campaigns, gather copious amounts of assets — and invest poorly. For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors.
And disappointed customers are voting with their wallets - and assets. The total number of mutual funds has been on the decline.
Total number of mutual funds (Source: Investment Company Institute)
The market share lost by mutual funds is not surprisingly shifting to ETFs. ETF fees tend to be lower, yet they provide better liquidity and the ability to time the market, including intraday trading. That makes ETFs appealing not just to retail investors, but to institutions as well.
IndexUniverse: Exchange-traded funds pulled in twice as much new money as mutual funds did in 2011 in what amounts to the latest sign that the ETF juggernaut is gathering momentum, increasingly at the expense of mutual funds.
Traditional mutual funds gathered $58.58 billion in net new money in 2011, according to estimates by Morningstar, the Chicago-based financial data firm. That compares to inflows of more than $119 billion into ETFs last year, according to data compiled by IndexUniverse.
It’s a surprising outcome in that the mutual fund industry is about seven times as big as the ETF industry in terms of assets under management.
The chart below shows that the competition for market share, at least in the equity asset class, really started around 2006 as asset flows into mutual funds and ETFs diverged.
Source: Credit Suisse
The worst loss of assets has been in the actively managed mutual funds. That is not surprising given they tend to charge higher fees and on average underperform equity indices.
IndexUniverse Without the inflows into passive funds, actively managed funds of all stripes shed about $6.7 billion in 2011.
This trend should continue as investors look to the most efficient products to express their views. And right now paying fees for an actively managed fund that is expected to underperform just doesn't look that efficient.
The trend of preference for fixed income mutual funds over equity funds that started in 2009 continues today. Recent data from Credit Suisse shows clear risk aversion with taxable bond fund flows beating out equities by a substantial amount.
Source: Credit Suisse
What about non-taxable bond funds? For a while there it was rough going with Meredith Whitney hyping up the doomsday scenario for munis. Fund outflows in late 2010 spiked, but as investors started to realize that default rates are not going to be nearly as extreme as predicted, investors started coming back, attracted by great after-tax returns.
Source: Credit Suisse
In the equity mutual fund space the period of 2009-2010 saw many investors betting on foreign equities (see chart below), particularly emerging markets. By the second half of 2011 that bet wasn't working out for them and fund outflows picked up from both domestic and the foreign funds.
Source: Credit Suisse
Some have attributed the equity mutual fund outflows to recent preferences for ETFs because of the ability to trade those intraday. That is indeed the case as equity ETFs have taken market share from mutual funds, though not enough to offset the overall decline.
Source: Credit Suisse
But some of this ETF flow increase has been driven by institutional investors as hedge funds and even endowments got a taste for the liquidity of ETFs. Retail investors on average continue to shy away from equities.
These trends are likely to continue into 2012 as the combination of stresses in the eurozone and zero short-term rates will combine risk aversion with search for yield to favor bond mutual funds over equities.
The world of junk bonds (HY) has been particularly turbulent this year. The market not only experienced tremendous volatility, but also saw significant divergence in the performance of different quality bonds. With risks of global recession constantly circling the markets, investors started gravitating toward higher rated, lower leverage names. In spite of the recent stabilization in the HY market, the "CCC" component continues to lag the higher rated paper.
JPMorgan Domestic HY Index for BB, B, and CCC bonds
The credit market is pricing in some probability of a substantial slowdown in the US that will rapidly increase the debt to earnings ratio for CCC-rated firms, making them vulnerable to default.
But there is another factor driving HY volatility this year. With significant interest in corporate bonds from retail investors, mutual funds and ETFs have been a big driver of supply/demand technical. And investors have been trading that market rapidly, trying to time the rapid “risk on”/”risk off” fluctuations. That translated into erratic inflows and outflows for HY mutual funds on an unprecedented scale as the chart below shows.
This fund flow volatility in the HY markets will continue to whipsaw market participants, exacting pain on those who don’t have the staying power to ride out the Europe-driven market storm.
That's right, a product that was a few years ago reserved for retirees and institutional investors - insurance, pensions (more retirees), etc. is now the darling of retail investors. Institutions and foreigners still hold the bulk of US corporate bonds, but the retail share via mutual funds and ETFs is growing each year (see below in blue).
Source: Credit Suisse
In fact until recently corporate bond mutual fund assets have been growing rapidly - a trend started in 2009.
Source: Investment Company Institute, Bloomberg
The same trend can be observed in ETFs. A popular corporate bond ETF is the iShares iBoxx Investment Grade Corporate Bond Fund or LQD. The chart below shows the growth in LQD shares outstanding.
LQD Shares Outstanding (Bloomberg)
So why all this interest in corporate bonds? One key reason is that retail investors continue to shy away from equities.
Brad Barber: My sense is that sentiment for equities isn't going to get positive until the economy is on strong footing. Even though the market has come back, it hasn't really been accompanied by robust economic growth. That can to some degree explain why retail investors remain skittish. The back story of the returns has just not been strong for the last year or two.
So far retail investors have been correct. Corporate bonds have outperformed equities significantly. As the chart below demonstrates, on a total return basis (including dividends and interest) LQD has outperformed the S&P500 by some 8% this year. This outperformance has been caused by falling rates in the US and stagnating equity markets driven by "macro" concerns. And as long as there is not a full resolution in Europe, this trend may continue.
Mutual fund flows show a clear preference for fixed income, which in part explains some of the rally in credit. The charts below from Credit Suisse/AMG show the striking difference between equity and bond fund flows this year.
After making billions off the backs of rich people, a growing number of hedge funds are betting they can strike gold by morphing into mutual funds and targeting the middle class.
Well it's not like the mutual fund industry has been doing charity work. Billions have been made in fees by mutual fund managers of some absolute dogs. Long only funds that charge 1% - 1.75% fees for "stock selection" have gotten rich on the backs of the middle class.
In 08 an average hedge fund lost about 22%, while equity mutual funds got hit with a loss that's about double that. And there were some real winners in the mutual fund space, like the Winslow Green Growth which is down 62% or the Legg Mason Opportunity, down 66%. Many would rather take their chances with a diversified portfolio of hedge funds.
"If you're a half decent hedge fund, it shouldn't be that difficult for you to become a top-quartile mutual fund," said one hedge exec.
With that in mind, even in this regulatory environment, firms are trying to launch mutual funds that invest in a pool of hedge funds. Here is a press release from Van Eck:
Van Eck Launches Multi-Manager Alternatives Mutual Fund; Designed for Retail Investors Seeking Exposure to Hedge-Style Investment Strategies
... launch of its new Van Eck Multi-Manager Alternatives Fund (ticker: VMAAX), an open-end mutual fund designed to give investors exposure to a variety of investment strategies, including absolute return strategies. This launch was a natural fit for Van Eck, as the firm has been managing a similar strategy for over six years as an investment option for variable life and variable annuity insurance contracts
So this option to allocate to hedge funds already exists for investment choices in various insurance products.
AQR Capital Management LLC, among the world's largest hedge fund managers, will introduce another hedge fund-style mutual fund next month, as it expands its reach beyond the biggest investors.
AQR has actually already launched a hedge fund mutual fund called AQR Diversified Arbitrage Fund (ADAIX). Here is a description from the prospectus:
AQR Diversified Arbitrage Fund (Absolute Return Fund) The Fund invests in a diversified portfolio of arbitrage and alternative investment strategies employed by hedge funds and proprietary trading desks of investment banks, including merger arbitrage, convertible arbitrage, and other kinds of arbitrage or alternative investment strategies described more fully below. The Sub-Adviser tactically allocates the Fund’s assets across alternative investment strategies with desirable anticipated returns based on market conditions. ... The Fund will also engage extensively in short sales of securities.
Finally a mutual fund that can short (without necessarily being a bear fund.) However, this one isn't exactly for the "middle class":
And they hit you with some nice fees that are on top of what the portfolio hedge funds charge. But that's the price you pay for getting the liquidity of a mutual fund while investing in what effectively is a hedge fund of funds.
The performance is shown below - a nice steady climb typical of a hedge fund of funds (until there is a systemic problem like in 08). This is likely to track something like the Credit Suisse Tremont index (with some lag due to higher fees).
But given how limited the choices are in the traditional mutual fund space (even though there are thousands of funds), this type of product will be welcomed (hopefully with some lower minimum investment requirements).
