Build a better mousetrap, and the world will beat a path to your door. For investment firms, the "better mousetrap" is a fund that has appeal because it promises a good return without exposing the customer to more risk than he can bear.
For more than a decade, contenders for the "better mousetrap" designation have included mutual funds that use hedge fund strategies. Such funds seemed to offer the best of both worlds: hedge-fund-like diversity and ability to adapt to different market environments without costing as much to participate. And they have the liquidity and transparency (investors can see how and where their money is invested) of mutual funds.
The traditional mutual fund went long on a mix of stocks, but that was just a part of the repertoire of these alternative funds. They also do things that were traditionally the province of hedge funds, selling short, investing in derivatives, managing futures and engaging in arbitrage.
After gradual growth for a few years, the popularity of hedge-style mutual funds exploded after the financial crisis of 2008 as investors, especially those close to retirement, sought ways to protect their nest eggs against calamity. These funds were viewed as better positioned to defend assets in a bear market, said Josh Charlson, director of alternative funds research for Morningstar.
Meanwhile, a lot of hedge funds had not been doing much hedging, Charlson said. They were pursuing big returns, and they took a beating, he added.
Hedge-fund-style mutual funds pursue a wide variety of strategies and it is difficult to generalize about them, but they can be a good way to balance a portfolio and help preserve assets, Charlson said.
After the trauma of 2008, hedge-fund-like mutual funds offered shelter from the storm. Many investors cared more about shelter than chasing double-digit returns, and firms created products to accommodate them.