Sean Spicer isn’t the only person who enjoys spending time among the hedges. Managers of mutual funds are increasingly looking to launch hedge strategies too.
In 1995, there were only two hedge funds run by firms that were also offering traditional funds. By 2014, that figure had climbed to 61. Today, most of the world’s largest asset managers also have true hedge-fund arms, rather than simply housing alternative strategies in open-ended structures. These groups include BlackRock and Pimco, and even Vanguard has its Alternative Strategies fund, which is only available to its institutional clients.
There are plenty of reasons for this trend. Cynically, of course, the higher fees typically attached to hedge funds will be welcomed by managers under threat from the passive industry. A more positive interpretation would be that running a hedge fund is prestigious and rewarding for the manager, so fund groups launch them for their stars in order to help retain them.
These are not mutually exclusive explanations, as a new study of the phenomenon by John Bae of Elon University and Chengdong Yin of Purdue University illustrates. They posited that if exploiting their managers’ skill rather than their clients’ credulity is the motivating factor for mutual fund firms venturing into the hedge fund world, it should be observable in their vehicles’ performance.
Bae and Yin used survivorship-bias-free information from Lipper and the Center for Research in Security Prices to construct a database of what they termed ‘side-by-side’ firms: those that offer both mutual and hedge funds, broken down into mutual managers that have developed hedge desks and hedge businesses that have established mutual capabilities.
They required funds to manage at least $5 million and have two-year performance records, and they also eliminated outliers at the 1% and 99% levels. With a sample period of January 2001 to December 2014, they identified 853 mutual funds and 192 hedge funds in side-by- side firms, including 83 individual managers who simultaneously headed at least one mutual portfolio and one hedge portfolio.
In aggregate, the double-hatted groups boasted superior funds. Mutual funds in side-by-side firms outperformed those in mutual-only families by a statistically significant seven basis points per month, net of fees. They also attracted more money overall, with inflows that were 0.31% higher per month than groups without a hedge division.
Bae and Yin found the same pattern when delving deeper into the data to assess the performance of managers with both mutual and hedge mandates, compared with peers who only steered mutual funds. Here, mutual funds whose managers also ran hedge strategies beat their peers who did not by 14.61 basis points a month, equivalent to 1.75% each year. This jumped to an even more impressive 0.21% per month, or 2.52% per year, when any funds run by the manager in other asset classes were stripped out of the data.
Interestingly, the reverse was true of hedge managers who dabbled on the mutual side. When managers from a hedge background also ran a mutual portfolio, they lagged their peers by 26.76 basis points a month – 3.2% per year. This could be because their efforts are directed more towards their hedge product, or because they struggle when their use of tools such as shorting or leverage is constrained.
Paying for stardust
So when asset managers grant their stars a hedge platform, they do tend to shine. And the glow touches the firm’s own finances too. Those groups with dual hedge and mutual managers secured inflows that were 38.27 basis points per month higher than their competitors without side-by-side managers.
‘Investors may view the side-by-side practice of mutual-fund management firms as a good signal and invest more money,’ Bae and Yin suggested.
Clients, then, should not worry about any potential loss of focus if their managers are handed new responsibilities on a hedge fund; it probably just means that they have backed a star. They should probably avoid hedge titans trying to build new retail franchises though.