A number of equity mutual funds are now looking to include shorting in their arsenal of tactics and maneuvers - a potential sign that fund managers don't see a reprieve to the bear market anytime soon.
Leading fund companies, including OppenheimerFunds of New York, CDC Nvest of Boston, Montgomery Asset Management of San Francisco and Legg Mason of Baltimore, are asking shareholders of a number of their funds to allow fund managers to short the market. Although the firms declined to comment, and some industry analysts questioned whether any of the funds would actually employ such a risky strategy, the shareholder letters spell out a clear intention to boost performance should market conditions persist.
CDC Nvest is asking shareholders of the CDC Nvest Targeted Equity and CDC Nvest Star Value funds for the ability to maintain short positions to "contribute to the funds' long-term performance" and give the funds "greater investment management flexibility to respond to changed market conditions." The fund would also like to be able to invest in firms that deal in real estate, commodity futures and options.
Reasoning that their portfolio managers should be able to "take advantage of changing investment opportunities," Oppen-
heimerFunds is asking shareholders in the Oppenheimer Disciplined Allocation Fund and Oppenheimer Value Fund permission to purchase securities on margin, make short sales and deal in puts, calls and commodities.
Seligman Capital Management of New York is also asking shareholders in its Seligman Capital Fund to allow it to short the market. The proxy says the portfolio manager has no immediate intention of shorting the market but would like to be able to do so in the future.
The Henlopen Fund of Kennett Square, Pa., is another fund that wants permission to reduce its equity exposure by selling securities and exchange-traded funds short. The reason, said Michael Hershey, president and chairman of the fund's advisor, Landis Associates, "is to have some flexibility to deal with markets. The market is not gonna pull itself together."
Jim Shirley, an analyst with Lipper of New York, said the firms' proxy filings with the Securities and Exchange Commission could point to a trend among fund managers seeking a way to hedge their long positions in this miserable market, particularly should there be any further "significant drops."
"Fund companies may see this as an opportune time to expand their investment strategies to give their managers more wiggle room,'" Shirley said.
"Additionally, fund companies may be noticing that one or more of their current funds, or a competitor, is gaining assets in funds having the ability to use short positions."
Hedge funds have been portrayed positively in the news this year, and fund companies may see increased flexibility as an opportunity to meet a demand for this kind of fund, Shirley continued.
While the filings stipulate that the funds are simply seeking permission to short the market at some future time without having to bring the matter to shareholder vote, they lay the groundwork for "them to get into the game of selling short," said Mercer Bullard. Bullard is a shareholder activist and former SEC commissioner now based out of the University of Mississippi.
And while existing funds are looking into having shorting written into their bylaws, a number of leading firms are bringing funds devoted to shorting or taking market-neutral positions onto the market. Earlier this month, Charles Schwab of San Francisco introduced the Schwab Hedge Equity Fund, and Merrill Lynch came out with the Merrill Lynch Long-Short Technology TRAKRS.
Aetos Capital Management of New York filed with the SEC in early August to offer a series of four closed-end funds that will employ short strategies, as well as arbitrage and invest in distressed stocks. Likewise, AIP Alternative Strategies Funds of Chappaqua, N.Y., is planning to introduce the Alpha Strategies I Fund, a fund that will use a wide variety of investment styles, including shorting and derivative investing, to respond to "adverse market, political and economic conditions."
"The ability to produce positive returns is stimulating the creation of retail versions of hedge funds, [which] were once only available to the very wealthy or institutions," agreed Phil Edwards, managing director of global fund research at Standard & Poor's of New York. Edwards added that short funds are "one of the few sectors like REITSs or gold, that has provided positive returns in the past few years [see MFMN 8/19/02]. After all, investors have an interest in positive returns," he said.
"There's been a steady increase in filings for market-neutral funds" over the past few years, Shirley added.
A snapshot of the recent performance of funds looking to short the market makes it understandable why mainstream funds might be exploring alternative investment strategies. The Henlopen Fund is down 25% year-to-date through Aug. 20, according to Morningstar of Chicago. The Legg Mason Europe Fund, another fund looking into shorting, is down 21% year-to-date. The Seligman Capital Fund, yet another, has lost 29% of its value.
In fact, 93% of all equity mutual funds suffered losses in the second quarter, according to Weiss Ratings of Palm Beach Gardens, Fla.
By comparison, the AXA Rosenberg Market Neutral Fund, run by AXA Rosenberg Investment Management of Orinda, Calif., is up 33% year-to-date through Aug. 15, according to Lipper. And the Phoenix-Euclid Market Neutral Fund, run by Phoenix Investment Partners of Hartford, Conn., is up 34% year-to-date.
While the spate of filings seems to signal a trend, Bullard cautioned that it may just be fund companies are finally taking advantage of the elimination of the Internal Revenue Services' Short-Short Rule in 1997. The rule essentially precluded mutual funds from shorting the market by heavily taxing those earning more than 30% of their annual gross income on securities kept less than 90 days. Funds that did not comply faced a 35% corporate tax bill on all income, with a tax on shareholder's dividends as well.
Bullard said fund firms' need to respond to the change was not pressing at the time the Short-Short Rule was lifted and that the current rash of filings with the SEC is merely a matter of companies catching up with the law. He said changing the bylaws to include shorting was not an immediate concern for many of these companies in 1997 and that they were not about to have a special shareholder vote for just this one issue.
Shirley said the timing could be a coincidence, but it does seem suspect with the current conditions in the market.
He cautioned, however, that fund managers might not be equipped to take on this kind of investment strategy, which could lead to additional risk, and that shareholders could be penalized with additional trading costs, fees and taxes. In addition, it is worth noting that there are only a handful of these esoteric funds devoted to shorting the market, and none of the leading fund trackers Lipper, Morningstar or S&P even break them out into separate categories.
"Asking shareholders for this kind of flexibility is asking them to take on a newer level of risk. The onus is on the fund company to convince you that this change is truly going to enhance the overall performance of the fund without significantly changing the cost of the fund or your tax implications," Shirley said.