The typical fees of a hedge fund-usually structures where the manager takes a fee of 1% of assets and 20% of profits-and the lack of regulation and transparency are the main reasons the firm stays away from hedge funds, he says. With fund of fund products, he maintains, those issues remain and are compounded by an additional layer of management and its associated fees, he adds. "You're taking two leaps of faith," he says. "The first is in the actual investment in whatever fund. The second is to trust whoever the person is picking these hedge funds."
Some advisors have found adequate diversification through the use of mutual funds that use hedge strategies, such as the Merger, Arbitrage and Gateway funds, Calamos Market Neutral, Caldwell and Orkin Market Opportunities, and Leuthold Core Investment funds.
Richard Schultz, president of Schultz Financial Management in Santa Ana, Calif., went on a search for alternatives after the stock market went south in 2000.
Dissuaded from using hedge funds because of high minimum investment requirements and high fees, he started to put clients into the Calamos Market Neutral Fund, which uses an arbitrage strategy of holding convertible bonds and shorting their underlying stock. "It was market neutral and it was hedged," he says. "It's actually expected to do a little better in a down market than even a sideways market because of the short plays on the stock."
The fund, which is now closed to new investors, brought returns of 10.3% in 2000, 8.3% in 2001 and 6.6% in 2002.
At Legend Financial Advisors in Pittsburgh, such mutual funds, as well as fund of hedge funds products, such as one offered by Undiscovered Managers, are used as the building blocks for low-volatility portfolios, says firm President and CEO Lou Stanasolovich. "They are designed to provide equity returns of 8% to 12% with minimum volatility," he says. "They're not going to follow the market upward, and they're not going to have wide swings."