The Hedge Fund Report: Getting What You Pay For

A lot has been written about "hedged mutual funds," which use hedge-fundlike trading strategies such as short selling and leverage.

Those hybrid funds resemble mutual funds in two ways: They are subject to strict regulations and they do not charge performance-based fees. A few have proven popular with investors.

What nobody has really bothered to look at is how these vehicles compare with hedge funds in terms of performance. A recent study by the London Business School called "Poor Man's Hedge Fund" says that the news isn't good.

The only time these funds don't significantly underperform hedge funds, the study found, is when they are run by hedge fund managers themselves.

The reason is simple: Hedged mutual funds don't pay as well, says Vikas Agarwal of Georgia State University, one of the report's authors. Another conclusion is harder to explain -- hedged mutual funds also fail to outperform traditional mutual funds. One would think that with more flexibility, hedged mutual funds would do better than their mutual fund cousins. But here again, it takes skills to short, and such skills don't come cheap.

At the Gate

A lot of hedge fund executives worry the industry will be a victim of its own success, and many are beginning to express concerns that the jig is up.

At a conference last week, Paul Roth, partner at Schulte, Roth & Zabel, a top hedge fund lawyer and lobbyist, recounted a recent taxicab ride in which his driver claimed to be investing in hedge funds.

Meanwhile, Michael Steinhardt, the famous investor and former hedge fund manager, recently wrote an editorial in the Wall Street Journal entitled "Do you really need a hedge fund?" In Steinhardt's view, hedge funds have become asset gatherers that collect management fees tied to the assets, and are more concerned with capital preservation than with performance.

"This is a different business than the one I knew," he wrote. With the average management fee at 1.5% of assets, "managers don't merely cover overhead, they make a profit -- before they earn their clients a dime."