Hedge fund investing may be shifting from the tony, high-net-worth crowd to main-street mutual fund owners.
, a $112 billion broker-sold fund giant in Boston, is developing three hedgelike funds that investors could buy into for as little as $250. The funds currently are "incubated" -- they're available only to MFS employees -- and MFS has not yet decided whether to make them available to the public. But their performance -- one has returned 118% over the past 12 months -- and unique strategies are already turning heads.
"It's an interesting idea: a hedge fund for Joe Six-Pack. Hedges are popular and have an appeal to investors because they're associated with rich investors," says Jeff Benjamin, a consultant and hedge-fund specialist at
in Boston. "For $1,000, it might be fun to try."
Hedge funds are unregulated, pooled investments that typically employ risky strategies to make hedges -- or large bets -- on market index, security or sector price swings. These strategies include derivatives (bets on security, commodity, rate or currency prices), leveraging (investing borrowed money) and short-selling (selling borrowed stock in hopes of buying it back at a lower price later on).
It's estimated that there are more than 5,000 hedge funds with as much as $350 billion in assets.
These funds stay beneath the radar of regulatory requirements by operating as limited partnerships with fewer than 500 investors. Investment minimums often start at $500,000, and to invest in the funds, investors often must prove their net worth is over $1 million.
The three funds --
Vertex U.S. All-Cap
-- started early last year. Like most MFS growth funds, they seek capital appreciation and have reasonable investment minimums ($1,000, or $250 for IRA investments). There's also a 5 3/4% sales charge, or load. Although they are mutual funds according to the
Investment Company Act of 1940
, they have broader investment parameters than many fund investors have ever seen.
Vertex All-Cap and Vertex Contrarian can invest up to all their assets in emerging markets. All three can invest 100% of their assets in derivatives, cash and/or short sales. The funds are nondiversified (allowed to build large positions in few securities), can leverage investments by borrowing up to 50% of the fund's assets and can invest 15% of their assets in unregistered or illiquid securities.
"These funds should behave and perform exactly like an equity hedge fund," says Steven Lonsdorf, president of
Van Hedge Fund Advisors
in Knoxville, Tenn.
"I guess it shows how flexible the '40 Act has become," says Benjamin. He adds that if the funds were launched, investors would have to be comfortable with higher peaks and valleys than with standard stock funds.
The funds' annual expenses, ranging from 0% to 3%, are also modeled on those of hedge funds. Each fund's base annual management expense is 1.5%, but that fee rises or falls 0.1% monthly for every full percentage point that the fund has outpaced or lagged the
index over the previous 12 months.
MFS spokesman David Oliveri says the funds, and their Vertex brand, were started to diversify the fund shop's image as a growth fund manager. Oliveri says there are no plans to launch the funds in the next six months, but they've earned places in several of the media's top-10 scorecards.
The funds' reins are in the hands of veteran in-house growth managers with no past hedge fund experience: John Balan (Vertex All-Cap,
MFS Emerging Growth), Paul McMahon (Vertex U.S. All Cap,
MFS Growth Opportunities) and Brian Stack (Vertex Contrarian,
MFS New Discovery).
"With hedge funds, even more than with normal mutual funds, performance all comes down to the manager. That's because of the broad mandates and latitude," says Lonsdorf.
Oliveri and the funds' managers can't comment specifically on how each fund is being managed, since
National Association of Securities Dealers
rules prohibit marketing funds not available to the public.
Ironically, Vertex All Cap was originally managed by John Brennan, who left the firm in February with fellow high-profile MFS manager Chris Felipe to start a hedge fund. Brennan was not available for comment.
The MFS funds are "kind of cool, but it's really just a distraction," says Joel Davis, a senior financial planner at
American Express Financial Advisors
in Augusta, Maine. He adds that if the funds' were launched, investors should limit their exposure to 3% to 5% of assets. Otherwise, the funds' unpredictable portfolios could skew an investor's asset allocation.
Davis and Cerulli's Benjamin agree the funds are best suited for MFS's broker-sold channel, where advisers can educate investors on the strategies' risks and monitor their client's risk exposure over time. Davis worries that if the funds were launched, white-hot performance could lead investors to ignore the significant risks. "How many people do you think really read a prospectus?" he asks.
Apparently MFS has prepared for a lukewarm reception from brokers. According to the funds' prospectus, if launched, MFS may offer brokers and their firms enhanced commissions for selling shares of the funds through
sales contests and a similar incentive program called
Oliveri estimates that most incubated funds are usually launched or abandoned after three years. According to that timetable, these funds' fate may be decided in the next year and a half.