Mutual fund firms are considering offering hedge funds and related products in order to prevent portfolio managers from leaving to work for existing hedge funds, said industry executives.
Attracted by higher compensation and a greater degree of independence, many portfolio managers are leaving traditional mutual funds for hedge funds, according to Gregory P. Barrett, executive vice president with HedgeWorld USA, of Rye, N.Y.
"What you are seeing is a classic case of brain drain," he said. "Talented people are leaving mutual funds to start hedge funds, so where do you want to put your money?" HedgeWorld USA tracks the performance of and provides other data on over 2,300 hedge funds on its website, HedgeWorld.com. Barrett made his comments at the Schwab IMPACT 2000 Conference in Denver last month.
Hedge funds' allure has grown stronger over the past few years due to their higher compensation rate, said Ryan Tagal, an analyst with Cerulli Associates of Boston. Hedge fund managers generally work for a performance-based fee that pays them 20 percent of a fund's gains, he said.
In addition to higher compensation, some notable defections to hedge funds have prompted many managers to leave mutual funds for hedge funds, he said.
"Jeff Vinik, a former manager with Fidelity started a hedge fund three years ago," Tagal said. "When he did that I think a lot of managers thought, Hmm, I can do that too.' And a lot have thought about it and have done just that."
Managers also like the freedom hedge funds afford, said Roy Weitz, a financial advisor and publisher of FundAlarm.com, a website that tracks manager changes in the fund industry. Hedge fund managers are usually free to make a variety of investment choices, do not have to answer to a board of directors and are not subject to SEC regulations, he said.
But some fund firms are taking steps to prevent managers from seeking these advantages elsewhere. Alliance Capital of New York started offering hedge funds in 1994 as a means of keeping its managers from leaving for outside hedge funds, said Shira Zackai, a spokesperson for the firm. Alliance currently offers 21 hedge funds with a total of $3 billion in assets under management. Besides keeping managers from straying, the firm's hedge fund business has proven to be an area of strong growth and the firm is optimistic about its continued growth, Zackai said.
The firm does not recruit outside managers to run its hedge funds and its managers receive the 20 percent performance-based fee typical of most hedge funds, she said.
The firm has had notable success in stopping portfolio manager defections.
"Since we began offering them in 1994, we haven't lost any managers to hedge fund boutiques," Zakai said.
Putnam Investments of Boston has been considering offering hedge funds through a strategic partnership it formed in July 1999 with Thomas H. Lee Partners, a private equity firm, also of Boston, said Matt Keenan, a company spokesperson. The new firm, TH Lee, Putnam Capital, currently sells a venture capital fund to high-net-worth investors and institutions.
But Putnam may have waited too long. Nigel Hart, co-manager of the Putnam International Voyager fund left the firm Sept. 15 to run a hedge fund, said Keenan.
Putnam is not alone. In the past year, 12 managers from various funds have left to either start their own or run an existing hedge fund, according to data posted on FundAlarm.com.
Many firms are wary of offering hedge funds because they are viewed dimly as risky investments, said Tagal.
But, hedge funds are somewhat unjustly labeled as high-risk investments, he said.
"If you look at a majority of hedge funds, they do have less risk than most mutual funds," he said.
Still, a few highly-publicized failures of hedge funds have given the products their risky reputations. The failure of George Soros' fund and the bail out of Long Term Capital of Greenwich, Conn. in 1998 keeps many fund companies out of the business, Tagal said.
"There are a lot of perceived risks ... funds have to be careful about what their image is," he said.