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Mutual Funds That Act Like Hedge Funds

Richard Widows

12/27/06 - 09:31 AM EST

With regulators raising the bar for hedge-fund investors, there's never been a better time to consider mutual funds that try to produce consistent returns by zigging when the market zags.

Hedge fund fees have always been off-putting -- they typically charge hefty 2% management fees and also keep 20% of any profits they earn for investors. Investors may also object to having their money locked up for a year or more.

But now the Securities and Exchange Commission wants to redefine who is rich enough to invest in hedge funds; earlier this month it proposed redefining "accredited investors" as those with a net worth of $2.5 million, compared with $1 million currently.

In reality, you have to be more than just comfortably well-off to invest in hedge funds, since $1 million is just the price of admission for many of them. But in recent years it has become easier to get a foot in the door through funds that pool investor capital to invest in other hedge funds. The proposed rule would severely limit the potential investors in these funds of hedge funds.

Still, the concept of producing positive returns in good markets as well as bad is appealing, particularly to those who suffered through the tech stock wreckage a few years back. And investments designed to steadily outperform money market funds by several percentage points are likely to appeal to many investors. So for those unfortunates with a net worth of $2.4 million or less, I have screened TheStreet.com Ratings' database of open-end mutual funds for those meeting the following criteria:


Alternatives to Hedge Funds
These mutual funds have returns that are virtually uncorrelated with the S&P 500 index
Name, Ticker and TSC Ratings Grade 1-yr. Total Return (%) 3-yr. Alpha Coef. (%) 3-yr. Beta Coef. 3-yr. R-Sq.(%) 3-yr. Std. Dev'n(%)
Allianz NACM Pacific Rim A (PPRAX) C+ 27.68 17.88 0.25 0 41.64
Caldwell & Orkin Mkt Opportunit (COAGX) E+ 5.67 0.33 -0.29 8 4.76
Diamond Hill Long-Short Fd Cl A (DIAMX) A+ 18.82 12.16 0.48 19 8.00
Federated Market Opportunity A (FMAAX) D 6.03 2.85 0.03 0 4.90
Fidelity Real Estate High Income Fd (N/A) C 9.90 8.05 0.04 1 6.67
Forester Value Fund (FVALX) D- 3.74 8.65 -0.27 3 11.35
Franklin Templeton Hard Curr Adv (ICHHX) D- 11.01 0.33 0.28 15 6.00
Gabelli ABC Fund (GABCX) C- 12.16 2.20 0.17 18 1.99
ING PIMCO Total Return S (IPTSX) D+ 5.62 0.70 0.05 2 3.00
James Advantage Market Neutral A (JAMNX) D -1.81 3.09 -0.13 2 6.00
JPMorgan Multi-Cap Mrkt Netral A (OGNAX) D+ 6.29 0.84 0.14 4 3.33
Laudus Rosenberg US LgMdCp L/S Inv (RMNIX) D+ 7.35 2.66 0.02 0 5.49
Laudus Rosenberg Value Lg/Shrt Inst (BMNIX) D 0.30 0.19 -0.02 0 4.90
Nations Mort & Asset Backed Port (NMTGX) C- 6.60 0.43 0.06 17 2.42
Pinnacle Value Fund (PVFIX) C 10.94 7.07 0.33 16 5.83
Robeco Boston Ptrs Lg/Sh Equit Inv (BPLEX) C+ 13.26 10.43 -0.08 0 7.78
Select Environmental (FSLEX) E+ 10.73 0.04 0.22 11 13.64
Data as of 11/30/2006.

The 17 that met the above constraints are the antithesis of the "closet index" funds that I discussed in an earlier article. Most have returns that are virtually uncorrelated with the S&P 500, with beta coefficients within a hair of zero. In fact, five have R-squared values of zero, meaning no correlation with the market. These are the rugged individualists of open-end mutual funds, the Daniel Boones who shun the crowds, driven by the urge to fearlessly march off into terra incognita.

Moreover, the individualism of these funds hasn't resulted in inconsistent returns. The "hedge" in the concept conveys a degree of immunity from sinking markets. Some of the component funds boast three-year standard deviations considerably below the average of 10.21% for all open-end stock funds.

Of course, the steadiness of these returns comes at a price. While these hedge-fund-like mutual funds tend to make money in good times and bad, the returns tend to be on the modest side. This accounts for the equally uninspired grades earned by most in the group from TheSteet.com Ratings.

Another "cost" of the funds in the adjoining group is a higher-than-average mean group total expense ratio of 1.57%. Still, it pales next to the two-and-20 standard of the hedge-fund industry.

With names such as "Long-Short," "Market Neutral," "Hard Currency" and "L/S," seven of the funds are overtly declaring themselves to be in the hedge-fund domain. And even if, as individuals, they don't necessarily produce returns that are uncorrelated with the overall stock market, some of these funds could help diversify your portfolio. In addition to the currency fund, there is an energy fund, a Pacific Rim foreign-stock fund and two that focus on the real estate sector.

So if the SEC puts hedge funds out of your reach, don't worry. Investing in one of the funds on this list means you will still have something to boast about at your next cocktail party.

Brokerage Partners