The Hedge Fund Report: Another One for the Masses

American Century gets into the long/short mutual fund game.
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It's becoming obvious that many mutual funds have hedge fund envy.

A few weeks ago, we reported that

Janus Capital

(JNS)

is planning a new mutual fund product with many hedge-like characteristics. Now, $100 billion mutual fund giant American Century has followed suit with the launch of the

American Century Long-Short Equity Fund

(ALHIX).

The product will take both long and short positions to generate returns that it hopes are uncorrelated to overall market performance. The long/short feature mimics hedge fund investing, while the fund remains open-ended, available to all investors with a minimum of $2,500.

Hedge fund pros don't think highly of these kind of products. One of their criticisms is that mutual fund managers -- who specialize in picking stocks that rise, not fall -- aren't qualified to run a long/short portfolio.

Kurt Borgwardt, one of the new fund co-portfolio managers, says that his group already runs $13 billion in four long-only funds and that the switch to shorting is not a big deal. Borgwardt notes that mutual fund managers, who are usually judged according to benchmark indices, make a bearish call on every index component that they choose not to buy.

Maybe. But mutual fund managers don't have to deal with the operational headaches of covering their shorts. That, says hedge fund managers, is what makes their job so tough to learn.

Sports Book

Sports Authority

(TSA)

announced on Jan. 23 that it will be acquired by Leonard Green & Partners for $37.25 a share at the end of June. That leaves merger arbitrage hedge funds with several ways to play the leveraged buyout.

One trade is to buy the stock outright. At a $36.42 current price, the return over four months is less than 5% annualized. This trade appeals mainly to those who believe that someone else will bid up the stock, says Troy Johnson, a trader at the hedge fund Quixote Capital.

Johnson doubts that will happen and therefore does what is called a buy-write. He buys the equity and increases his overall return by selling in-the-money calls on the stock. On Friday, he bought the stock at $36.56 and sold March $35 calls for $1.95.

This trade gives him downside protection if speculation about another bidder subsides. As long as the stock stays above $35, the trader is in the money and should be able to generate a roughly 10% annualized return. Johnson doesn't see the deal falling apart before March 17, and that means that he is confident that the stock price will stay above $35. If another bidder surfaces, he is still in the money.

What he is really giving up is participation in the possible upside.

There are many ways to play this trade, he says, and it all depends whether one assumes a counter-bid is coming or not. Those who don't are doing just what Quixote does: buying the equity and writing calls. The other camp buys either the stock or the calls and hopes for another bidder.

Continental Shift

The European exchanges are in consolidation frenzy, and hedge fund pressures can't be ignored. But will they rule the outcome?

The most recent development is Atticus Capital and British hedge fund TCI raising their stakes in Euronex to 9.1% and 8.4%, respectively. Euronext was formed by the merger of the Paris, Brussels and Amsterdam exchanges.

The hedge funds are pushing for a merger between Euronext and Deutsche Boerse, because they own significant stakes in both. But getting a deal done isn't easy. Euronext and Deutsche Boerse have huge derivative operations, and their merger may raise antitrust issues with the European Commission.

Traders continue to defect Wall Street for hedge funds. Ben Bram, who oversaw

Goldman Sachs'

(GS) - Get Report

equity trading in the health care sector, joined $1 billion Touradji Capital Management; Samuel Joab in Europe left

Merrill Lynch

(MER)

to be part of a new pan-European equity long/short team at $6.4 billion Greenwich, Conn.-based FrontPoint Partners; and Centaurus Capital poached

Lehman Brothers'

(LEH)

investment banker Benoit D'Angelin to manage a credit and special-situation portfolio.

Good Turnout

So far this year, 962 hedge funds have signed up as investment advisers with the

Securities and Exchange Commission

following enactment of a new rule requiring registration. The additions bring to 2,131 the number of funds that are now registered, including outfits that took the plunge prior to this year, says Robert Plaze of the SEC's Investment Management Division.

What is exactly the impact of this rule? It all depends on how many managers there are in the marketplace. That number is hard to compute, because database providers track the number of funds, not fund advisers. In general, the average firm operates two to three funds, and that implies there are around 3,500 to 4,000 management firms, says a database expert. Two years ago, the SEC predicted that 700 to 1,100 managers would register as a result of the new rule. With 962 new registrants, the agency is right on target.

With a little more than 2,000 advisers now registered, we are talking about a 55%-60% rate of registration. Not bad.

The SEC rule definitely has a broad impact. But it remains to be seen whether the commission will reach its goal to deter fraud. The rule also has loopholes, and while some have already taken advantage of them, others predict that corrections will be made.

One well-publicized aspect of the ruling is that it allows some managers to escape registration, provided that they have a two-year lockup. As a result, some have speculated that the SEC would amend this exemption to make it harder to qualify. Still, the impact of the loophole has been exaggerated. Hedge funds that benefit from the two-year exemption make up only 15% of the total, according to conversations Plaze says he had with lawyers.

"To modify the exemption, we would have to conclude that the goal of the rulemaking was not accomplished," he says. Considering the relatively high number of hedge funds that have registered, "I don't know if there is any plan to do that," Plaze says.

Still, the SEC can always amend its rule as it sees fit. "The two-year exemption was not designed to be a loophole," Plaze says. "It was created to differentiate hedge funds from private equity funds."

But as everyone knows by now, the lines between those two worlds are getting blurry.