The Hedge Fund Report: Getting What You Pay For

New 'hedged' mutual funds don't seem to be performing very well.
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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."

Steinhardt notes that the profession is the highest-paid in the world. "Yet, you don't need a license, a degree or even experience to start a hedge fund." If Steinhardt, a legend who belongs to the generation of George Soros, Warren Buffet and Julian Robertson, concludes that "today, performance is hardly spectacular," there might be cause for concern.

Institutionalized

"Three guys in a garage" were the hedge funds of the past. Today, banks and other giant firms run the game. And as a result, performance is less impressive and risk is more limited. That was another (arguably) pessimistic view expressed last week by Emil Henry, the Treasury Department's assistant secretary for financial institutions.

His speech was meant to reassure investors. But, in reality, the message was that hedge funds have lost their edge by becoming mainstream.

"There is less systemic risk in the hedge fund space than is generally perceived," Henry said. To him, the shock created by the blowup of LTCM served as a catalyst for the institutionalization of the industry.

Following LTCM's implosion, counterparties have grown more disciplined about the extension of leverage; investors have demanded and obtained more transparency; and risks are now better monitored. In other words, hedge funds may not be so hot.

New Frontiers

Lazard Asset Management rolled out early this month a long/short equity hedge fund. Overall, the firm has a $4 billion alternative investment division comprising hedge funds, private equity and real estate assets. Kun Deng, a managing director at Lazard Asset Management, will run the new fund, which is called Lazard World Alternative Value Fund.

The World Trust Fund Deng managed for Lazard returned 28.7% last year. Lazard declined to comment on its new fund.

Pershing Square hasn't had its last word on Sears Canada. Earlier this month, Bill Ackman, Pershing Square's founder, opposed

Sears Holdings'

(SHLD)

plan to buy out public shareholders of the northern affiliate for C$18 a share.

Now Ackman is enrolling other aggrieved shareholders in his battle, and with a group controlling 7.7% of the shares, vows to oppose Sears Holdings' bid for the Canadian retailer. Hawkeye Capital Management, Knott Partners Management and Pershing Square will take all legal actions to halt the sale or to obtain a better offer.

Ackman, a well-known activist, received a lot of ink this year for his successful campaign against

Wendy's International

(WEN) - Get Report

and a less triumphant duel with

McDonald's

(MCD) - Get Report

. Now his new foe is another Goliath: Ed Lampert, Sears Holdings chairman and the astute engineer of the Sears/Kmart merger. It's not going to be a breeze.

The Nobel Foundation, the institution that awards the Nobel Prize, is making a first foray into hedge funds. It selected Corbin Capital Partners, Rock Creek Potomac and the Carnegie Worldwide Long/Short Fund for money-management help.

Among those funds, Corbin, a $1.8 billion fund of funds, is the most recognizable name. Corbin was created by Glenn Dubin and Henry Swieca, the two founders of Highbridge Capital Management, a $10 billion hedge fund sold to

JPMorgan

(JPM) - Get Report

in 2004.

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