Equities have been in a bear market for more than a year and were on shaky ground for over a year before that.
During the past couple of years, I have been writing about alternative investments that, one way or another, offer a place to hide. The latest fund of this type is the
AQR Diversified Arbitrage Fund
, an actively managed fund that allocates money to various forms of arbitrage, including convertible arbitrage, merger arbitrage and closed-end fund arbitrage.
The fund invests in seven categories whose weightings are flexible. As of the most recent report, convertible arbitrage made up 25% of long positions, which makes sense as that market has been hit hard, creating inefficiencies that patient investors can exploit. If something changes, the fund can react quickly.
The fund's objective is to deliver a positive absolute return without a correlation to the stock market. These types of funds will continue to proliferate. ADANX is only a month old and as of Jan. 31, had only $7.6 million in assets. I would expect assets to rise quickly as the company expects to sell the fund through most larger discount brokerages later this month.
I tend to want to give these sorts of products a few months to prove themselves because not every fund achieves its objective. I have no reason to doubt AQR but, at the same time, there is no rush. Additionally, there is one strategic item I haven't seen in other absolute funds, which is that ADANX invests in special purpose acquisition corporations, also known as SPACs, which are trading to a discount to their underlying value. SPACs hold marketable, short-term securities until they find a company to purchase. If the market price falls below the value of this interim portfolio, ADANX might then buy that SPAC.
As of the end of January, the fund allocated 33% of its long positions to SPACs. Discounts can get larger before they get smaller. If there were some sort of unpredictable event -- how many of those have there been in the past two years? -- that hurts SPACs, ADANX would be pulled down with it.
The fund's expenses are capped at 1.50% until April 30, 2010, at which point the fee looks like it will go up to 1.75%. That may seem like a lot, especially for investors used to index funds, but absolute return funds are usually more expensive, and 1.50% is reasonable.
Some absolute funds have been very good places to hide. Depending on how long the crisis lasts, we all may need to allocate more to this space. I have allocated 5% to 6% of client accounts to absolute return (with different funds), and it is possible that more may be needed. These play into a larger theme I have been working on, which is that portfolio construction is evolving and these types of funds are playing a bigger role.
At the time of publication, Nusbaum had no holding in the security mentioned, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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