If one were to ask the average investor their general thoughts about hedge funds, the feedback would include things like specialized investment strategies, astute managers, large returns, high net worth individuals, and minimal regulations.  To this day, many see hedge funds as a symbol of the elite and wealthy.  Although this image of the space remains the same, there are many changes that are beginning to occur in this environment.

Many people have different assumptions about what a hedge fund is and what they do, but here is some basic information about the asset class.  The definition of a hedge fund according to Investopedia.com is, “An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short, and derivative positions in both domestic and international markets with the goal of generating high returns”.  There are approximately 6,800 hedge funds totaling over $2 trillion in assets under management (AUM).  Although this may seem like a large amount of money by itself, it’s still small in comparison to the $15 trillion in AUM in the 1940 ACT mutual fund (40 ACT) space.

One dynamic that is changing throughout the investment industry is the scope and diversity of strategies that exist in the 40 ACT mutual fund space.  There are more funds to choose from in the mutual fund space today compared to recent history.  Many of the “old” 40 ACT funds are “long only equity” and “fixed income” funds which are traditional investments.  These type of funds are still very useful and combined with the right managers, investors can still be very successful with these investments.  One thing that has changed in recent years has been the huge growth in the liquid alternative and hedge fund type strategies in the 40 ACT mutual fund space.  Even though hedge fund strategies are 18 times the size of alternative mutual funds, last year, 66 cents of each dollar invested in the alternative space went into the 40 ACT space over the hedge fund space.

One of the largest draws for investors is that these non-traditional mutual funds deploy similar strategies as various hedge funds and while still having competitive returns.  Some of these include: long/short equity, event driven strategies, managed futures, hedged equity, and various arbitrage strategies.  Not only have they shown themselves to be competitive, but mutual funds offer much lower fees.  Last year the top 25 hedge funds managers made a combined $21.1B, with David Tepper and Stephan Cohen at the top of the list who made $3.5B and $2.4B respectively.  Yes, those are “B’s” for BILLIONS!  These earnings are absurd and some would call them legalized robbery.  Most hedge funds have a “2 and 20” fee schedule.  The “2 and 20” means that they charge a flat fee of 2% on the AUM and they additionally charge 20% on any performance gains for that year.  These fees on average are more than double your average mutual fund, which help contribute to these managers’ huge salaries.

Even with the changes going on in the 40 Act space, there will also always be a draw to many of these hedge fund managers because the ultra wealthy want their money managed by the George Soros and John Paulson’s of the world.  Even though these factors may keep hedge funds relevant for a long time, the landscape of money management is changing.  In the mutual fund space, there is a much greater scope of alternative strategies and managers.  Many long time hedge fund managers have taken note of this development and have decided to open 40 Act mutual funds that replicate their hedge fund strategies.  They are able to run similar strategies but they give the investor added liquidity – something that isn’t available in hedge funds.  Due to the competitiveness of these 40 Act funds, we believe this transition will continue to occur and we see this as a great opportunity for retail investors.