A total of 33 new hedge funds have been registered with the Securities and Exchange Commission over the past 12 months. Eight new hedge funds have been registered so far this year, including new offerings from J.P. Morgan and Merrill Lynch, both of New York.

While some advisors have yet to formally launch their registered hedge fund, others are getting comfortable with the unique product they have brought to market. Overall, both large and well-known advisors, as well as small and relatively unknown sponsors, are intent on offering an appealing investment strategy, formulating a sound plan for distribution, and finding a comfortable niche they can occupy in an increasingly crowded marketplace.

Man Investments, located in Chicago, the U.S. investment unit of London-based alternative investment giant Man Group, entered the U.S. registered hedge fund industry in 2002. Leveraging the expertise of its U.S. asset management subsidiary, Glenwood Capital Investments, it began by offering the multiple-manager, multiple-strategy Man-Glenwood Lexington, a fund-of-hedge funds.

Its newest initiative is the Man-Glenwood Lexington TEI (tax-exempt investors) fund, which was developed solely for tax-exempt and tax-deferred investors such as endowments, foundations and individual retirement accounts. The new hedge fund came to market on April 1.

The innovative product was designed to eliminate unrelated business taxable income (commonly known as UBTI). Under current U.S. tax law, even tax-exempt organizations are liable for taxes on the income earned from leverage used in some hedge fund strategies.

"When a tax-exempt organization buys into a look-through product, such as a hedge fund, the earnings flow through to the tax-exempt organization which then pays taxes on this," explained Michael Tannenbaum, partner with the law firm of Tannenbaum Halpern Syracuse & Hirschtritt in New York. But, he continued, this UBTI does not flow out of offshore corporations.

The new Man hedge fund eliminates UBTI by investing in a Cayman Islands company that has a U.S. custodian and a U.S. bank account. That Cayman Islands company in turn invests substantially all of its assets in a master fund registered under the 40 Act, explained John Kelly, president of Man Investments. "Tax-exempt investors eliminate UBTI by investing through an offshore vehicle," he said.

Because hedge funds are taxed as partnerships, investors must pay the applicable taxes each year on their proportional share of the net income and gains on the fund, even if no distributions are actually received by the partner/investor, said Dave Anderson, managing director of GAM Services of New York, sponsor of the GAM Avalon funds, a family of registered hedge funds. "These are not terribly tax-efficient vehicles," he said. "But offshore vehicles do not pass through the UBTI."

Multi-Strategy or Single Discipline?

The predominance of hedge funds that have been registered with the SEC over the past few years generally fall into two categories: those that provide broad diversification across several alternative investment strategies through a single fund, and those that stick to a single discipline.

Broadly diversified hedge funds tend to have multiple managers employing multiple strategies. The fund advisor typically doles out allocations of assets to each chosen sub-manager, often a hedge fund manager, as it sees fit.

Single-minded hedge funds are more narrowly focused and invest within one segment of the alternative investment spectrum, such as merger arbitrage or managed futures. In some cases, advisors will offer multiple hedge funds, each catering to a different investment strategy. Advisers to broad-based registered hedge funds hope to use that flexibility to maximize returns.

The multi-asset, multi-managed Robeco-Sage Triton Fund, which was registered with the SEC this past December, seeks to take advantage of broad market opportunities. According to the fund's initial offering documents, the nimble fund can participate in any market, strategy or investment. The fund is managed by Robeco-Sage Capital Management of White Plains, N.Y., a wholly owned subsidiary of Robeco USA, which in turn is the U.S. subsidiary of the Robeco Group of Rotterdam, the Netherlands. A Robeco-Sage Capital Management executive declined a request for comment.

Of course, the multi-strategy approach does not suit everyone. That's why Aspen Partners, an investment advisor in Atlanta, last August registered to offer four hedge funds with different core investment disciplines, although it does embrace the multi-manager approach. The funds, all of which debuted this past February, are managed by Aspen Strategic Alliance, a wholly owned subsidiary. Offerings include the ASA Debt Arbitrage Fund, ASA Hedge Equity Fund, ASA Managed Futures Fund and the ASA Market Neutral Equity Fund. Guidance Capital, a registered investment advisory firm in Chicago, serves as sub-advisor to the funds and determines which hedge fund managers to hire within each of the disciplines.

Unbundling alternative investment strategies allows for better customization for the client, said Kenneth E. Banwart, chairman of Aspen Partners, which caters to fee-only registered investment advisers generally with $100 million to $1 billion under management. "Each fund has a different risk/return profile that allows you to custom allocate. These have a core allocation in each portfolio versus a one-size-fits-all approach," he noted.

"We haven't seen a lot of folks successful with [multi-strategy] funds-of-funds," Banwart said. With a multiple strategy product, it's hard to know what allocations are being made, he added. Still, multi-strategy hedge funds-of-funds are hot right now for advisors largely because they are more marketable and economical, he summed up.

On the Launching Pad

Coincidentally, Guidance Capital will also serve as the sub-advisor to the soon-to-be-launched Wilmington Low Volatility Fund of Funds. Rodney Square Management Corp., the asset management subsidiary of Wilmington Trust Corp. of Wilmington, Del., is the fund's advisor. This hedge fund, a first for Wilmington Trust, which caters to wealthy investors, was registered last August.

While the multi-strategy approach may be up for debate, the multi-manager philosophy is widely employed within registered hedge funds. But not all hedge fund sponsors want the task of selecting the perfect outside hedge fund managers to manage assets.

"The hedge fund industry can be a thorny thicket with thousands of hedge funds pursuing widely divergent strategies," confirmed Brian Ziv, a managing member of Guidance Capital. Guidance, which provides research about hedge funds' strategies, was formed three years ago with three former asset managers from Morgan Stanley.

Although Wilmington has gotten a green light from the SEC to offer its first registered hedge fund, assets have been slower than expected to trickle in, confirmed John R. ("Rusty") Giles, SVP of wealth advisory services at Wilmington. Wilmington employs about 70 internal investment advisers and private client advisers. Because of the fund's performance fee, the fund needs to have $25 million to launch.

Wilmington decided to offer the hedge fund because it wants to offer the same investment opportunities to all of its clients, whether they are $100,000 clients or $100 million clients, Giles said. As a longtime believer in the benefits of asset allocation, Wilmington recommends clients invest 10% of their portfolios in alternative investments. The fund is also unique in that it will cap its annual expenses to a flat 2%, Giles said.

But the firm has no desire to go commercial with its hedge fund offering. The vehicle is for Wilmington's clients only. "It is not something we've designed to mass market to brokers or anyone else," Giles affirmed.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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