Friday, April 12, 2013

And So It Begins: Hedge Funds for the Masses

And So It Begins:  Hedge Funds for the Masses

Last December, I noticed that several hedge fund of fund managers were preparing to launch mutual funds.  However, there wasn’t much information or data at that point because they hadn’t yet launched.  I’ve spent the last day looking at the Arden Alternative Strategies Fund (ARDNX), which formally opened to the public on March 12, 2013.  I have little doubt that this fund will be another overweight duck, which will draw in investors through its seeming stability and sink them with fees.[1]

The fund’s objective is to achieve capital appreciation while having a low correlation to the stock and bond markets.  The idea is that the underlying hedge fund managers, deployed across a variety of strategies, will not rise and full in full harmony with the public markets.  Amazingly, on the Fund’s fact sheet, the benchmark is listed as Citigroup 3-Month T-Bill Index, which currently yields 0.06%.  This is a laughable measuring stick.  Presumably the fund intends to beat a universe of other hedge fund of fund managers, such as the HFRI Fund of Fund Index, which has returned 4.9% in the last year.  This isn’t a lofty objective either.

Elevator Pitch (2001)

While there’s some possibility that the nine underlying hedge fund managers, plus two more that were just added, might provide some attractive performance for investors, count me as extremely skeptical.   First, the fund’s fees are 2.3%, and that’s just to pay Arden and mutual fund expenses.  I’m not sure why Arden needs a big management fee, as all the underlying managers are already used for other Arden assignments with big institutions.  Arden’s marginal cost for managing this product is near zero.

However, Arden is just the middle of the fee sandwich.  The top slice of bread is the fee the investor has to pay to their financial advisor[2] for providing financial services (at least 1%).  And, the bottom slice of the bread is the fee and carry paid to the hedge fund managers, plus the cost of all their trades (4% to 6%).  In other words, 8% goes out the door before the retail investor makes any money: A fully laden duck, indeed.

At the outset, Arden limited this offering to a minimum investment of $1 million and  follow on investments of $100,000[3], so the potential universe of investors was relatively small.  However, effective April 1, 2013  after a mere three weeks of trading, Arden opened up the fund to investments as small as $1,000, with add-ons and initial IRA contributions of $500.[4].  According to Morningstar, assets under management are at $924 million, so the fund is off to a good start, at least for Arden.[5]

While the marketing has been going fabulously, investors might be troubled to learn that the head of risk management was dropped from the investment committee.  In a January 2013 filing with the SEC, Arden amended the prospectus.   They simply stated that the committee was shrinking from five to four members.  I think the head of risk management, Matthew Bianca, has left the firm; I can’t find him mentioned on the company’s website or form ADV. 

In addition, the company’s first statement of holdings[6] isn’t encouraging if an investor or their financial advisor wants to figure out what’s going on.  The report aggregates the long positions of all the managers.   Thus you wind up with a long laundry list of stocks, bonds, ETFs, and options.   There are also two huge blind spots in the holdings list, a $105 million position in an Estlander Fund (one of the hedge fund manager’s offshore offerings) and $272 million in short positions.  While the holdings list complies with the SEC’s filing requirements, it’s transparency without meaning.

Why did Arden launch this fund?  Why will other firms follow suit?  The institutional fund of funds business is under a lot of economic pressure.  The performance has been mediocre and the management fees are coming down.  Ten years ago, when I was involved in these sorts of products, the institutional fee was about 0.75% with a performance incentive.  Today, those fees are probably down to 0.50%, at best, without any performance incentive.  So, it is time to take advantage of the last big market opportunity: the investing public.  Arden gets to triple its fees and appeal to the masses. 

[1] Last year, I wrote about the Endowment Fund (“Overweight Duck:  The Laden Version of the Endowment Model [October 30, 2012] managed by Salient Partners, which uses the fund of funds model to replicate the characteristics of a university endowment.  That fund only had quarterly liquidity, and was also invested in some private equity.  It suffered from poor performance and high fees.
[2] Class I Shares are offered primarily for: (1) investors who are clients of investment advisors, consultants, broker dealers and other financial intermediaries who: (a) charge such clients fees for advisory, investment, consulting or similar services., pg. 9
[3] Ibid, page 9.

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