More Funds Are Hedging Their Bets

Slowly but surely the mutual fund masses from Main Street are mixing with the hedge fund set on Wall Street.

Hedge funds were once reserved for well-heeled investors looking for alternative investments wherein they could safely pass on their wealth to the next generation. Staggeringly high minimum requirements and exotic-sounding investment strategies kept the average retail investor on the outside looking in.

That's changed over the past few years. The mutual fund industry has gradually been rolling out new offerings that use sophisticated hedge fund strategies, but are tailored to meet the needs of the growing number of savvy retail investors. Simultaneously, the number of hedge funds in the U.S. has mushroomed to an estimated 6,800 with about $860 billion under management, leading to a greater awareness of the once reclusive and exclusive investment vehicle.

"Investors have matured," says Jonathan Ferrell, portfolio manager for the (TOPFX - Cramer's Take - Stockpickr)Rock Canyon Top Flight fund. "More mutual fund investors understand hedge funds and the techniques they use now."

Dan Culloton, analyst at Morningstar, says he has seen more mutual funds employ hedge fund strategies in recent years as a means to appease both investors and portfolio managers.

"From an investor perspective, the bear market made market neutral strategies appealing," says Culloton, referring to a strategy where a fund goes long and short in the same sector or industry. "And on the other side, the fund companies were facing a talent retention issue. Their top managers were leaving to start hedge funds. By branching out into new hedge fund styled mutual funds, it keeps the managers home and the clients happy."

But just because retail investors finally have access to the same strategies favored by their wealthy neighbors does not necessarily mean it is without risk.

Hedge Funds vs. Mutual Funds

Like mutual funds, hedge funds pool investors' money and invest it in financial instruments in an effort to make a positive return. But unlike mutual funds, hedge funds are not registered with the Securities and Exchange Commission This means that hedge funds are subject to very few regulatory controls. In addition, many hedge fund managers are not required to register with the SEC and therefore are not subject to regular SEC oversight -- although that could soon change under new agency rules being considered.