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Ted
Copy & Paste Barron's 2/22/14: Beverly Goodman
Noted investment manager KKR caused a bit of a stir earlier this month when it announced it will close two of its entrants into the mutual fund arena.
It's not that the funds themselves were so notable. In fact, they're about to be shuttered because they failed to get any traction in the year they were open. But it speaks to the difficulty of the ongoing quest to incorporate alternative investment strategies into a mutual fund format—and who can offer the most elegant solution.
In the case of KKR's two funds, it seems clear that mutual fund companies had an advantage. KKR is a pre-eminent investment manager, with much more name recognition than the typical hedge fund firm, and yet its mutual funds couldn't compete. It wasn't a matter of performance: The KKR Alternative High Yield fund (ticker: KHYKX) returned more than 7% last year, beating the category average, but the firm acknowledged in a statement that the fund simply had too many established competitors (a "very crowded marketplace") with long track records. The KKR Alternative Corporate Opportunities fund (XKCPX) returned 14% in 2013, but was an overly complicated hybrid product that came with an onerous initial-investment process and "lacks the daily liquidity most mutual fund investors expect." Both funds in about a year took in just $33 million, on top of KKR's $125 million in seed money.
And yet investors appear to be clamoring for alternative-investment strategies in a mutual fund structure. Hedge funds saw $6.9 billion in outflows last year, while liquid alternative mutual funds took in $40 billion, according to Morningstar data. And that category doesn't include fixed income: Another $55 billion went into unconstrained or nontraditional bond funds, the mutual fund answer to fixed-income and credit hedge funds. With some $360 billion in assets, hedge funds still dwarf the $139 billion in alternative mutual funds—but may not for long.
Many alternative managers, however, are now realizing that their investment expertise isn't enough to make them successful among retail investors. "Mutual fund firms are just better at navigating the landscape and understanding the business," says Josh Charney, an alternative-investment analyst with Morningstar, adding, "They've been marketing products since the dawn of time. Hedge funds have only been allowed to market since the JOBS Act went into effect."
Indeed, the big winners have been offerings from mutual fund firms. Long/short equity funds took in $20.5 billion last year, though the lion's share, $13.4 billion, went into just one fund—the $21 billion MainStay Marketfield fund (MFLDX), which saw its assets triple. It returned 16.9% last year, versus 14.6% for the long/short category. Performance helped, certainly, but MainStay is a part of New York Life, which has a 150-person sales force. "We don't even think of Marketfield as an alternative fund," says Steve Fisher, president of MainStay Funds. "It's just a mutual fund with a very flexible approach. Our distribution model helps advisors understand how our funds fit into a portfolio."
Hedge funds face challenges in reaching mutual fund investors, and developing relationships with their advisors. Mutual fund firms, meanwhile, face challenges in terms of hiring the talent necessary to manage alternative portfolios. Alternative mutual funds often carry a management fee near the 2% charged by most hedge funds, but they're not allowed to pay managers a portion of the gains—making it a much less lucrative opportunity for the manager.
RATHER THAN A PITCHED BATTLE between alternative managers and fund companies, though, the approach we're likely to see more of going forward is one of collaboration. Mutual fund firms can use their name recognition and marketing and sales prowess, and rely on the investing expertise of hedge fund managers. Many alternative mutual funds use subadvisors to manage assets. One of the most successful examples is Blackstone's partnership with Fidelity—in terms of both the development and execution of the final product.
Last August, the two firms launched the Blackstone Alternative Multi-Manager fund (BXMMX); its $1.2 billion in assets is allocated across 12 hedge fund managers including Cerberus, Wellington Management, and Caspian Capital. It's only available to the high-net-worth clients of Fidelity's Portfolio Advisory Services group. It's an exclusive arrangement for one year, but John McCormick, director of Blackstone's alternative asset management group, says the fund's appeal for "mom and pop investors," could also lend itself to inclusion in a 401(k) plan, variable annuity, or other insurance product.
Blackstone initially approached Fidelity several years ago with an idea for "a very different sort of product," McCormick says. After extensive talks and reworking, the two firms arrived at a fund that could exploit Blackstone's heft in the hedge fund world and Fidelity's reach in the retail world. "We're the largest allocator to hedge funds in the world," McCormick says. "If we ask them to build something special, they do it."
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