Coming soon: hedge funds via web

A Chicago consulting firm that specializes in alternative investments is starting an online program that offers independent financial advisers access to 200 screened hedge funds as well as data about them.

Hedge Fund Research LLC is capitalizing on the growing number of financial advisers who want to protect their clients from volatility. Suddenly, hedging for the sake of hedging — instead of trying to beat the market — is back in vogue.

“We want to do for hedge funds what Schwab did for mutual funds,” says Scott Burney, a managing director at HFR, which will make the database available in a couple of weeks.

Since hedge funds operate as virtually unregulated private investments, it is difficult to place them into specific style categories as in the case of mutual funds. While a hedge fund’s basic investment strategy is laid out in a boilerplate legal document, the language usually provides enough flexibility for the manager to stray.

New York-based Hennessee Group LLC, which tracks 21 styles, exemplifies some of the variations that exist. The macro style popularized by the likes of George Soros seeks to capitalize on changes in the global macroeconomic environment through participation in various capital markets. Market neutral, also known as long/short equity, could be described as a classic hedging style. This fund might have near-equal long and short stock exposure.

As variations on the market neutral strategy, there are short-only and long-only styles, which are used as hedges against one another or by managers who are particularly bearish or bullish.

The fragmented market of more than 12,000 independent financial advisers is viewed as an untapped source of hedge fund capital, and HFR is betting that the professional advisers will see the benefits of moving client assets into hedge funds.

“There’s a shift by advisers to try and move upscale, and hedge funds can help them do that,” Mr. Burney says. “And for hedge fund managers, which are not known for their marketing abilities, these are assets that they haven’t had before.”

Even with the overvalued stock market and record market volatility, not to mention a growing crop of millionaire investors, HFR’s plan is not wrinkle-free. Advisers still aren’t completely sold on hedge funds.

Robert Hurley, president of Stoddard Management Co. in Rockland, Mass., says his clients have expressed curiosity — but never any real interest — in hedge funds.

“Hedge funds are the sophisticated way to lose money, as opposed to the more mundane way,” Mr. Hurley quips. “It’s my experience that people who have the financial wherewithal to invest in hedge funds eventually become disenchanted.”

Then, there are fees; hedge funds typically charge 1% of assets and keep 20% of the performance. This would be added to the 1% annual fee already charged by the adviser.

Hedge funds also come with investor qualifications that start at a net worth of $1.5 million. The platform — called HedgeFundSource — will be free to advisers and, initially at least, will only be made available to professional investors. Mr. Burney could not rule out the possibility that individual investors might be allowed to participate in the future.

HFR currently has more than 70 agreements with firms representing more than 200 hedge funds to participate in the online program, screened from HFR’s database of 2,000 funds. The goal is to have 500 hedge funds participating in HedgeFundSource by the end of the year, Mr. Burney says.

own due diligence

Advisers will have access to additiional information in order to conduct their own level of due diligence before investing.

“Financial advisers have been receptive to hedge funds from a risk/return perspective that shows the long/short equity hedge strategy fits into any asset allocation model,” Mr. Burney says. “From a numbers standpoint, it looks like a no-brainer.”

Mr. Burney earlier tried to bring hedge funds to the adviser market.

In August 1999, as president of Diversified Strategies, Mr. Burney was piecing together a fund of funds, designed for financial advisers.

When he joined HFR last fall, the Diversified Strategies plan was “folded into HFR,” he explains.

Frank Napolitani, vice president of Quantus Holding Co., a New York-based hedge fund, says volatility has turned investor attention toward downside risk.

“It’s not the returns that investors are focused on right now,” Mr. Napolitani says. “People come on board with us for the down months.”

Even as most hedging strategies have traditionally been able to illustrate their worth in down or flat markets, many of these high-cost alternative-class investments have seen their performance pale as of late in comparison to the skyrocketing equity markets. Take Quantus’ Tiburon Asset Management hedge fund, for example.

The hefty 116% return in 1999 didn’t quite reach the 134.8% return of the average science and technology mutual fund over the same period.

Meanwhile, hedge funds, once known for their own skyrocketing returns, have begun to re-emphasize their origins, and their abilities to dodge some of the downside that has been doing so much damage lately, particularly in the technology and biotechnology sectors.

Hedge funds may never belong in the mainstream of investment products, but the industry is becoming less of a closed club.

Since the $3.6 billion bailout of Long-Term Capital Management LP in 1998, hedge funds have been providing investors and lenders with more details on portfolio holdings.

And, while the presidential task force assigned to evaluate the industry is not likely to apply new regulatory oversight, additional pressure for due diligence has been applied to the banks and institutional investors that support hedge funds.

Evidence of the industry’s evolution can be seen in moves by such institutional investors as the California Public Employees’ Retirement System, which last year allocated a $300 million slice of its $160 billion pension fund — the nation’s largest public fund — to hedge funds.

General Motors’ pension fund, the largest in the corporate sector at more than $85 billion, is also known to be considering an allocation to the alternative asset class.

Hennessee points to its index of long/short equity hedge funds, which gained 41.8% in 1999 with only three negative months. This compares to the S&P 500 Index, which gained 21% and had five down months last year.

“As you have volatility, the ability to go short or long on the turn of a dime has its advantages,” says Hennessee CEO Charles Gradante. “We’re seeing a lot more interest in hedge funds for that reason.”

Tremont Advisers, a hedge fund consulting firm based in Rye, N.Y., posts a hedge fund index on its web site to illustrate how hedging can help investors in a volatile market.

Over 2000’s first two months, while the S&P 500 and the Dow Jones Industrial Average dropped 7% and 11.9%, respectively, the CSFB/Tremont Hedge Fund Index gained 6.4%.

Some were worth the extra bucks you pay for them. In the 1990s, growth hedge funds returned 23.26% with a standard deviation of 15.07%.

Compare that to the S&P 500’s 17.78% return with virtually the same amount of volatility. Market-neutral funds, which got slammed in 1999, returned a mere 14.15% for the decade, with only a 7.32% standard deviation.

On the other hand, macro portfolios returned 15.25% during the same period with a standard deviation of 16.22%.

“Now that the S&P actually recorded a couple of down months, people are asking about what hedge funds have been doing,” says Barry Colvin, Tremont’s director of research. “The market has punished investors in January and February, and that has piqued the interest of [potential hedge fund] investors.”