The heat is on this summer, but the temperature of the registered hedge fund of funds marketplace is anything but sizzling. In fact, it is getting a downright chilly reception.

Registered hedge fund of funds' managers are facing significantly lower returns than they saw in 2003 and 2004, along with an asset base that, in many cases, has either eroded or been slow to build. In addition, managers are facing other complications that include a frenetic, trendless stock market and one specialized investment strategy that hopeful managers had allocated assets to. That strategy, known as convertible arbitrage, has endured its worst year since 1999.

Money Management Executive recently combed through the annual reports of sixteen registered hedge fund of funds that employ multi-managers and multiple strategies and recently filed with the Securities and Exchange Commission. These particular funds have March 31, 2005 fiscal year-ends. We wanted to see how they were doing; what their performance has been, which investment strategies they are allocating the greatest percentage of assets to and how asset inflows have been (see accompanying chart).

The result? It's been a rough year.

Many of these registered hedge funds of funds first came to market in 2002 and 2003 when a flood of advisers, some migrating from the mutual fund industry, some from the traditional hedge fund industry, pounced on the fertile registered hedge fund of funds marketplace. A few are veterans, starting as early as 1999 or 2000. Since then, at least one adviser has pulled the plug on its four funds (see MME, 2/24/05) and others are weighing their options.

While the push to launch registered hedge funds of funds has slowed since then, another 14 funds from eight advisors have been registered or debuted so far this year. These include five new funds from Credit Suisse First Boston, all of which went live April 1, two from Morgan Stanley Alternative Investment Partners, an affiliate of Morgan Stanley, and two from relatively unknown Coast Asset Management of Santa Monica, Calif. which in February registered one leveraged and one non-leveraged hedge fund of funds.

AmEx Fund "Spinning" Its Wheels

While some funds are suffering from performance drag and results that are a fraction of their previous year's total return, the $44.5 million Advisory Hedged Opportunity Fund from American Express Financial Corporation is now officially in limbo, thanks to the imminent spin-off of American Express Financial Advisors from American Express Financial Company announced in February.

As part of the fallout from that spin-off, the two-member investment team that had been managing the 20-month old registered hedge fund was strategically moved over to American Express Bank. American Express had previously consolidated its non-US and US hedge fund platforms into a single, global platform under the auspices of the bank, explained Paul Johnson, company spokesman. But since American Express Bank is not a US registered investment advisor, it cannot serve as the advisor to this registered hedge fund of funds.

Consequently, the fund's recently filed annual report noted that, lacking an investment team, the fund's board was left to what to decide the fund's fate. The board's evaluation is expected to conclude by July 31. The fund, which is sold through American Express' network of advisors, has since suspended the sale of shares. Although he declined to speculate as to the outcome, Johnson noted that options include assigning the fund to another firm or liquidation. The fund returned 9.72% from inception through March 31, 2005 and allocates assets among eight investment strategies.

Ironically, as of Mar. 31, 2005, the fund had allocated the largest portion of its assets, 22.13%, to event-driven strategies, which includes mergers, acquisitions, spin-offs and other corporate events.

Shifting Strategies

From the annual reports, we gleaned that most multi-strategy fund managers have shifted assets into event-driven strategies and long-short equities and/or relative value and opportunistic strategies, and predominantly out of convertible arbitrage which has taken it on the chin.

According to the Dow Jones Hedge Fund Strategy Benchmarks, the convertible arbitrage hedge fund strategy has suffered a loss of 8.2% year-to-date through June 20, 2005.

That loss has translated into a performance trouncing for a number of more traditional unregistered hedge funds, which, in recent weeks, have pulled the plug on their funds and returned assets to investors. These include Marin Capital Partners of San Rafael, Calif., which two weeks ago closed its $1.5 billion convertible bond hedge fund. And last week Bailey Coates Asset Management, with offices in the UK and the U.S., pulled the plug on its flagship Cromwell Fund.

Registered hedge funds of funds have been suffering right alongside their unregistered counterparts, although multi-strategy funds are better protected when the bottom falls out on a single strategy.

Desperately Seeking Alpha

"2005 has been a tough year; one of the hardest years," said George Lucaci, managing director of Channel Capital Group in New York which runs the HedgeFund.net Web site. The convertible arbitrage strategy has been especially difficult, compounded by the healthcare and technology sectors, which themselves have performed poorly, he said. "People are looking for niche strategies that can continue to produce alpha."

That quest has produced a conundrum for many investors who specifically turned to the alternative investments industry as a way to grab performance where the stock market was flat or in negative territory.

"The main reason people turn to hedge funds is to gain access to non-correlated asset classes," said Phil Edwards, managing director of the investment services division of Standard & Poors in New York. The unusual challenge right now is that neither the hedge fund market nor the S&P 500 index is doing very well. "There's not a lot that's working right now," he conceded.

Year-to-date through June 20, the S&P 500, which is generally regarded as a broad based representation of the US equity market, has eked out a 0.35% return, with the energy and utilities sectors almost single-handedly driving performance, Edwards said. In 2004, the S&P 500 returned 8.99% for the full year.

In contrast, the S&P Hedge Fund Index is showing red ink, down a marginal 0.02% through June 20, 2005. For the full year 2004, the S&P Hedge Fund Index returned a better 3.88% and an even frothier 11.1% in 2003 as the bear market lingered.

Playing for Assets

Raising assets has been an important consideration for registered hedge fund of funds managers. Although it has had positive performance over the past three years, the six-year old Whistler Fund, managed by Advantage Advisers of New York, an affiliate of Oppenheimer & Company, has seen assets dwindle from $136.8 million at March 31, 2003 to $127.5 million two years later.

Those that have been successful in attracting assets include the OFI Tremont Core Strategies Fund which is co-managed by Tremont Partners and its parent OppenheimerFunds of New York which, since its Jan. 2003 inception, has amassed $240 million, the J.P. Morgan Multi-Strategy Fund which has soaked in $86.9 million since its Aug. 1, 2004 debut and Merrill Lynch's Multi-Strategy Hedge Opportunities Fund which launched Jan. 3, 2005 and bulked up with $73 million in its first two months of operations.

One of the largest registered hedge fund of funds comes from General Motors Investment Management in New York, the investment management unit of General Motors Corp. The fund commenced operations four years ago this month, but first registered with the SEC as an investment company in Nov. 2002. As of Mar. 31, 2005, the fund managed a whopping $1.9 billion, up from $629 million at March 31, 2003.

But it isn't upscale retail investors that have been flocking to the auto maker's hedge fund doors. More than 86% of this hedge fund of funds is owned by First Plaza Group Trust. That is the group trust that represents the various employee benefit plans of GM and its affiliates. However, it is interesting to note that for its fiscal year ended Mar. 31, 2005, this mega fund earned almost $17 million in management fees.

(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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