By Sree Vidya Bhaktavatsalam Nov. 24 (Bloomberg) — JPMorgan Chase & Co . and Pacific Investment Management Co. are inundated with money from individuals attempting to mimic the performance of hedge funds speculating that the stock-market rally is over. So-called bear-market and long-short mutual funds, designed to protect against falling stock prices, attracted a record $10 billion this year through October, more than double the previous high in 2006, according to Morningstar Inc. Asset managers have opened 19 long-short funds, the most in one year. The funds’ rising popularity shows how skeptical small investors remain even after the Standard & Poor’s 500 Index recouped almost half the 57 percent loss incurred from October 2007 to the March 2009 low. Conventional mutual funds that only buy U.S. stocks posted $4.6 billion of redemptions in the first 10 months of the year, while bond funds added $280 billion. “Companies are capitalizing on the uncertainty in the market,” Nadia Papagiannis, an analyst with Chicago-based Morningstar, said in an interview. “There’s also a mystique that comes with hedge-fund investing.” The best-seller among the funds is Hussman Strategic Growth, run by economist John Hussman of Ellicott City, Maryland. It drew $1.7 billion through September after limiting its loss last year to 9 percent, according to Morningstar, less than half the average of hedge funds. The $3.4 billion Highbridge Statistical Market Neutral Fund , run by JPMorgan’s Highbridge Capital Management LLC, pulled in $1.5 billion. At Pimco, the world’s largest bond manager, Bill Gross ’s Fundamental Advantage Total Return Fund raked in $786 million, Morningstar’s data show. Budget Hedge Funds Long-short funds buy stocks as well as sell them short. In a short transaction, the investor sells borrowed shares in a bet that the price will subsequently fall and the stock can be purchased and the loan repaid at a profit. These funds hold more long positions, or those that make money when prices rise, than shorts. Bear-market funds typically hold more short than long trades, and also invest in securities such as commodities that may rise when stocks fall. Most conventional mutual funds don’t short stocks. The alternative funds have been around since at least 1977 and had sales increases after the dot-com bubble burst in 2000. They mostly target people who aren’t wealthy enough to invest in hedge funds, the lightly regulated private partnerships that are typically open only to clients with a net worth of at least $1 million. Wider Appeal Like other mutual funds, alternative funds are overseen by the U.S. Securities and Exchange Commission and operate with restrictions on the investments they can hold. They also face limits on a tool employed freely by hedge funds: borrowed money, which can be used to amplify returns. Alternative funds are also luring some hedge-fund investors attracted by the ability to withdraw money on a daily basis, said Jed Laskowitz, head of global strategic relationships for the fund unit of New York-based JPMorgan , the second-largest U.S. bank after Bank of America Corp. Investors were angered last year when some hedge funds froze or limited redemptions amid the market’s plunge. They were also alienated by Bernard Madoff’s Ponzi scheme, which has cost investors $21 billion. “Part of the growth is from investors looking for safe havens, part of it is among clients not wanting to give up liquidity,” Laskowitz said. Increasing Allocations A majority of institutions and financial advisers said alternatives will account for more than 10 percent of their portfolios over the next five years, according to a Nov. 16 survey by Morningstar and Barron’s magazine. A quarter of those polled expect to have more than 25 percent of their investments in that category. Alternative-investment products currently account for less than 1 percent of the $10.8 trillion mutual-fund industry. Hedge funds oversee $1.45 trillion and recorded inflows of $10.2 billion in October, according to Eurekahedge Pte in Singapore. Traditional hedge-fund investors including pension funds and endowments have said they’re seeking more liquid investments after struggling to raise cash during the credit crisis. Harvard University in Cambridge, Massachusetts, the wealthiest U.S. school, sold $2.5 billion of bonds in December, cut jobs and postponed building projects. Gartmore Sees Convergence Gartmore Group Ltd., a British manager of about 21.8 billion pounds ($36 billion) that announced plans for an initial public offering last week, said it’s aiming for a “convergence” of hedge-fund and mutual-fund investments. “A lot of people don’t want to have another situation like they did in 2008 where they can lose 40 or 50 percent again,” Chief Executive Officer Jeffrey Meyer said Nov. 20. The S&P’s rebound this year may limit the growth of alternatives in the near term, says Burton Greenwald , an independent mutual-fund consultant in Philadelphia. “As the public returns to the equity markets, they will be less interested in these somewhat exotic products,” Greenwald said. “Given a year or two of traditional stock-market returns, their memories might prove to be very short.” In the U.S., mutual funds aren’t allowed to borrow more than a third of their assets to amplify returns. This in turn limits how much stock they can short. The rules curb the funds’ ability to react quickly to changing markets, potentially limiting returns and their appeal for hedge-fund investors, said Vidak Radonjic , a managing partner at Jersey City, New Jersey-based Beryl Consulting Group LLC. “Mutual funds are heavily regulated and hence often respond to market shifts more like an oil tanker and less like a kayak,” he said. Comparative Returns Hedge funds returned 17 percent this year through October, according to data from Hedge Fund Research Inc. in Chicago. Long-short mutual funds rose 9.6 percent, while bear-market mutual funds declined 33 percent, Morningstar’s data show. The S&P 500 returned 17 percent, including reinvested dividends. In 2008, bear-market funds gained 30 percent while their long-short counterparts fell 15 percent. Hedge funds lost an average of 19 percent. This year’s inflows suggest some investors may be willing to accept a less spectacular performance in return for liquidity and lower fees. The average annual fee on long-short funds is 2.1 percent, compared with 2 percent of assets and 20 percent of profits at hedge funds. While cheap compared with hedge funds, fees on the alternatives are double those of traditional U.S. stock funds. Long Not Enough Besides short sales, long-short and bear-market funds use strategies such as arbitrage and derivatives. Arbitrage seeks to exploit inefficiencies in security prices, while derivative contracts such as swaps enable wagers on or against assets. “Mutual funds are losing assets, and it might be that they are looking to salvage some of the market share they are losing to hedge funds,” Peter Rup, chief investment officer at New York-based Orion Capital Management LLC, which invests in hedge funds, said in an interview. “The long-only strategy is antiquated,” he said. JPMorgan filed an SEC registration statement in August to open the HighBridge Dynamic Commodities Strategy Fund, which would use commodity-linked derivatives to bet on oil, metals and agricultural markets. Barclays Global Investors, the San Francisco-based money manager that is being acquired by BlackRock Inc., on Nov. 16 opened an exchange-traded fund called iShares Diversified Alternatives Trust . The fund, BGI’s first that doesn’t track an index, uses futures and forward contracts to take long positions or bet against currencies, commodities, stock and bond indexes. Pimco Chief Executive Officer Mohamed El-Erian has said the world is in a “new normal” of eroding U.S. dominance and slower economic growth rates. Since his return in January 2008, the firm has opened two funds reflecting those views: Global Multi-Asset Fund and Global Advantage Strategy Bond Fund. “People realized that they had a lot more equity risk than they thought,” said Jon Short , head of the U.S. institutional business at Newport Beach, California-based Pimco. To contact the reporter on this story: Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net .
