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New Hedge Fund Minds Gap

It will target the discount to NAV in closed-end mutual funds.

A new hedge fund hopes to blend mathematical modeling with a knack for shareholder activism to squeeze profits out of closed-end mutual funds.

For several reasons, closed-end funds usually trade at prices that are below the combined value of their constituent holdings. Deeper discounts often reflect the market's poor opinion of a fund's manager, a fact that can attract activist shareholders who believe they can fix the problem in the boardroom.

Activist investors normally seek out such situations on a case-by-case basis. Another strategy uses quantitative analysis that looks for funds that are trading at illogically steep discounts. Rarely have the two methods been married -- until now.

Gramercy Investment Advisors, a $1.35 billion money manager, is preparing a fund, the Gramercy Global Optimization Fund, that will combine a proprietary quantitative model with hands-on activism. Gramercy hopes the new fund can beat the MSCI All Country World Daily Total Return Index, which has returned 7.26% this year.

The new fund will be small, just $130 million. But what it lacks in heft, Gramercy hopes to make up for in innovation.

The quant model, which the firm calls "portfolio optimizer," was developed by a team led by Nobel Laureate Harry Markowitz, and Markowitz will serve as a consultant with the investment team. Also managing the fund is portfolio manager Tony Tessitore, who used to run a fund in Chile that employed the optimizer model.

The model will winnow the universe of closed-end funds down to 250 potential opportunities a week. Gramercy, which specializes in investment strategies based on corporate news flow and turnarounds, will use its activist approach to make a final selection. Among the things it will consider is whether other activists are already pushing for change at the fund.

The reason activism works in the realm of closed-end mutual funds is that there's too many of them, said Thomas Herzfeld of Thomas Herzfeld Advisors Inc.

"There is a glut of closed-end funds that has caused spreads to widen considerably because you have too many funds with similar objectives," Herzfeld says. "The widening has been exacerbated by the competition of exchange-traded funds, which always trade at NAV. That will attract activists."

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