The AIP Alpha Strategies I Fund has dared to go where no other open-end mutual fund has tread before: into the hedge fund realm. The fund is the first to offer a variety of hedge fund investment techniques packaged as an open-end mutual fund sporting continuous sales of shares, daily liquidity and transparency of all securities, both long and short.
The fund launched last September with four sub-advisors in tow; each specialized in a different alternative investment strategy. With only $12 million in current assets under management, the fund is still trying to gain traction. But the two executives at the helm are convinced that hedge funds and mutual funds can successfully be married into a solitary product offering. Both are so enthusiastic, that each of their vanity license plates, in different states, reads ALPHX, the fund's ticker.
Money Management Executive Editor-at-Large Lori Pizzani sat down with Chief Executive Officer Steve Samson and Chief Investment Officer Lee Schultheis, the co-founders of the fund's adviser, Alternative Investment Partners of White Plains, NY, to discuss this enterprising fund.
MME: What inspired you to start this unusual hedge fund-like mutual fund?
Samson: Lee and I wanted to build a bridge between a traditional hedge fund-of-funds and the mutual fund industry. With our 15 years of experience on the mutual fund side, we recognized the inherent capabilities of mutual funds that weren't being utilized. We saw the opportunity to have a fund managed by the same people who manage alternative investment strategies for conservative investment portfolios, and to open this up to individual investors, retirement plans and institutions that have become more and more comfortable with these strategies but wanted transparency.
MME: Why build your bridge to connect to the open-end fund world and not pursue a closed-end fund or other format?
Schultheis: The old school of thought was to take a mutual fund and hedge a 10% slice. But I don't think that's what people really want. That's not what's driving people into hedge funds. They want absolute returns. Guys who invest on the long-only side are depending on the stock market to give them a return. We're not.
Hedge fund slices are illiquid. It could not be an open-end fund if we invested in hedge funds directly. We wanted a fund that offered daily liquidity and daily pricing.
With registered hedge funds you can sell more to people with lower investments, but there is still the accreditation paperwork. We wanted to use real hedge fund managers with multiple hedge fund styles, but put it into an open-end format. Our fund is designed to resemble a hedge fund-of-funds, but we have all of the transparency because we brought it up to the fund level.
MME: How did you decide on which managers to partner with for this fund?
Samson: We enlisted Trust Advisors of Fairfield, Conn., as our portfolio research consultant to do the manager selection for us. They looked at various managers and helped us build the portfolio optimization strategy. Then we contacted the firms they selected.
MME: Beyond diversity of styles and good performance, what were your criteria?
Samson: We wanted managers that managed hedge funds - not a manager who also ran mutual funds and might be competitive. Each of our managers is operating a separate account for us.
Schultheis: We wanted niche managers who managed from $50 million to $100 million of their best ideas, but still had enough capacity for us. We also wanted managers with the mentality of registered investment advisers (RIAs), not strictly hedge fund managers, where liquidity and transparency becomes an issue. We talked directly to some hedge fund managers, and it became abundantly clear that it wouldn't work with them.
MME: Was name recognition an important consideration in your selection process?
Schultheis: On the fixed-income side, it is important. You want a company with economies of scale, a sound process and a strong investment discipline.
Samson: That's not as important on the equity side. Sometimes you're better off having someone who operates under the radar screen.
MME: Do you expect to add to the four sub-advisors you now have, and if so, what area of the market would you like to tap?
Schultheis: We're happy with the mix right now, but expect that we will add managers over time. We envision as many as 10 managers down the road. You can still employ long/short strategies but with different correlations, especially within convertible arbitrage and fixed-income areas. As we get larger, we may want to get into more global, macro hedging.
Samson: We also think merger arbitrage is a good style that complements the other styles. But right now, there's not a lot happening in M&A.
MME: Who handles the allocation between the managers?
Schultheis: We do, and we change the allocations monthly as needed. Zacks Investment Management has about 25% of the fund now. It uses a proprietary earnings revision model and does long/short equity research. Twin Capital Management manages about 30% and does long-short equities with three subdisciplines: relative value, earnings revision and price reversal. CapitalWorks Investment Partners employs a convertible arbitrage strategy and has the greatest percentage to manage right now. That helps to dampen the risk profile. Smith Breeden Associates is on board but doesn't have assets allocated yet. They need $20 million to put their fixed-income strategy into play.
MME: The fund is less than one year old. What lessons have you learned so far?
Samson: For one, we learned that we were right - we could manage a product like this, and that there is a market for the fund. The professional managers in this industry really believe in this fund.
Starting out, we didn't know how the managers, for a small fund like ours, would allocate the assets. So our fund originally started out non-diversified. But we changed over to a diversified fund this past April.
At the same time, we shortened our 2% redemption fee period to 180 days from 365 days. In the beginning, we were afraid that we would attract market timers and we didn't want to have to allocate to managers, and then pull back. So we put a one-year holding into effect, but that didn't happen.
Schultheis: Operationally, after the first six months, we all got very comfortable. We realized that this was running very smoothly. We also worked out how to coordinate among the managers, which can be more of a problem with long-only sub-advisors. We can have situations where one manager is long a stock, and one is short the same stock. But we leave them alone to do what they do. Even if both managers took similar positions, right now each position is so small that it wouldn't add up to 1%.
MME: Is there a learning curve for attracting investors to this type of alternative investment fund?
Samson: The education issue is the one thing we underestimated. Even for experienced investors, mutual fund investors and hedge fund or affluent investors, there is a learning curve. They didn't really understand alternative investments. And as for RIAs, we found that they fall into two groups - those who know a lot about alternative investments, and those who aren't well informed. But RIAs are finding out about us and contacting us.
Schultheis: The biggest error we made was in assuming that our initial visibility would translate into assets and that it wouldn't take a big educational effort. We found out pretty quickly that our constituents needed to learn. It is like the 1991 Iraq conflict. You have to do the air campaign first, and then unleash the ground forces.
We haven't needed to do a 180-degree turn, but we have done a course correction.
MME: Why did you decide to offer this as a no-load fund, versus offering a broker/dealer or intermediary-sold fund?
Samson: By going no-load, we thought we would appeal to the mass affluent investors who could have qualified for a hedge fund but didn't want to commit to just one hedge fund. But we may bring out an A-share class.
MME: What are your plans to get word of your fund out to RIAs and market the fund?
Samson: We are compiling our own database of RIAs. We have several thousand names in that database right now that we are contacting with information. And we are adding trust departments and family offices that manage $3 million to $5 million. We are also talking to 401(k) plan providers, consultants and third-party administrators.
Schultheis: We are the only game in town with a multi-managed, market neutral fund available for 401(k) plans.
MME: What has been the reaction?
Schultheis: Some RIAs tell us that they won't even look at a fund unless it has a Morningstar three-year rating. But others are open to the idea. Most say they didn't think that you could do this in a mutual fund.
Samson: We know we are hitting a home run for people who understand the fund. We have had 10 hedge fund managers approach us, wanting to manage part of the fund. Some are emerging markets managers, but some have long track records. We refer them over to Trust Advisors for further consideration.
MME: Overall, how is the fund's performance?
Samson: The fund's risk profile has exceeded our expectations. Our performance has done well against other market-neutral mutual funds, and we've kept up with the performance in hedge funds, too, but with a lower beta.
We thought this fund would be revolutionary, but it looks as if it will be evolutionary. We still think it will get there and the fund is doing exceedingly well - just what we wanted it to do. Down the road, we'd like to be the mutual fund firm that has several of these funds, each with different risk/reward profiles.
Schultheis: Our net performance is what it is on a daily basis. Unlike hedge fund managers, we don't have to say, well, here's my performance, but wait a minute because I have to account for a performance fee.
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