Would a hedge fund-style mutual fund work?

Discussion in 'Trading' started by garfangle, Jan 2, 2004.

  1. Meaning, a fund set up such that it had a performance fee (~10%) above its management fee (~1-2%) but also adhered to many hedge fund rules that the performance fee would only be deducted if a fund is in a losing position once the investors were made whole (recouped back their losses). Moreover, the fund prospectus could state that it could trade by using derivatives, options, shorts, leverage et al. But as a mutual fund, it would not be so restricted as hedge funds are to market their product.
  2. Aaron


    Under the Investment Advisors Act of 1940, any performance fee charged to a mutual fund (other than a fund whose shareholders are all "qualified clients") must be a "fulcrum" fee. A fulcrum fee is one that increases or decreases proportionately with performance. In other words it is symmetric in that, besides rewarding outperformance, it also penalizes underperformance.

    Few money managers are willing to have a negative performance fee during a bad spell, so you don't see many fulcrum fees or mutual funds with performance fees.

    But if you register your hedge fund and only sell to "qualified clients", like Quadriga and a couple others have, you are free to charge a performance fee and to also make general solicitations.

    And, of course, all this is only applicable in the US. If you are in Italy (ref. your signature), I don't know what the applicable regulations are.

    Buon investimento!
  3. Babak



    I did not know that (fulcrum) !

    Tell me, do you know of any mutual funds under that structure currently in the US? Were there any under that law? If so, how did they perform?


    [learn something new everyday! :) ]
  4. Clarify: when you mean "negative performance fee" are you suggesting that the fund management will return to the shareholders of the fund an amount proportional to their loss as a percentage of the performance fee?

    For example: Would $100M ABC Fund w/ a 10% performance fee (ex-managing fees) that had trading losses of 25% in the most recent year (assets down to $75M not counting withdrawals) have to give back (inject into the fund) to the shareholders $2.5M from their (the managers/general partners) own pockets just as if they gained 25% they would keep an additional $2.5M on top of the managing fees?

    If that is so, then I can see why this strategy has not taken off outside of hedge funds. If they had one bad year or got off to a rocky start they (the fund management) could become insolvent, regardless of potential future performance.
  5. In Australia we have them. Minimum investment is $1000.

    THe Fund manager promotes it as a slightly higher risk product aiming to deliver an extra 3-4% over normal mutual fund returns P.A.

  6. This is a recent study (21 August 2003) on hedge fund management incentives (didn't read it yet):


  7. Legislation normally forbids that classical funds use derivatives, the reason given being that they are reserved to "sophisticated" investors, in legislation "sophisticated" investors means 1 million dollar to invest for each participant, since classical funds are for everybody and not only "sophisticated" investors it is not possible except if legislation change but who do these legislations ? And when derivatives are used it is forbidden to make marketing through prospectus.

  8. ktm


    Not sure what the hell you are talking about, Harry. Which "legislation" would this be. The 1940 Act? or some other arcane tidbit you've dug up?

    I have read a good number of both interpreted rules and the major Acts, and what you are saying does not make sense. In as simple terms as possible, everything is either a security or a commodity. Most derivatives on equities are securities, and are generally not distinguished from other products in the same category legislatively.
  9. Aaron


    Sure, there are mutual funds that use fulcrum fees. Fidelity and Putnum use them. The big Magellan Fund has a fulcrum fee, for example. For the Magellan Fund the performance fee ranges from ±0.20% of assets (not profits) — yes, only 20 basis points — so the total management + performance fee never goes negative. As I recall, the size of the performance fee depends on how the fund did compared to the S&P 500 over the prior 36 months.
  10. You know I never speak out of thin air :)

    Starting A Hedge Fund

    Marketing and advertising

    "You cannot have business cards that say investment adviser on them. You cannot let it generally be known that you are accepting new investors."

    "The only way to market your fund is via word-of-mouth to those individuals who you believe are already qualified to be investors. Understanding these restrictions needs to be an important part of your business plan. You want to make sure you are going to be able to attract enough investors to cover your expenses and earn a reasonable living for your trouble."

    "You cannot do a one-page summary of your offering documents. You shouldn't give out a chart of your performance results. Your offering documents must stand "on their own" - i.e., no embellishment. No other material can support your securities offering - no slick folder, no charts, no cover letter. Again, this makes the marketing process difficult, but that is part of the barrier to entry. (Plus, we don't want your less-savvy investors to think that the chart represents some rate of return that is guaranteed to be achieved in the future.) "

    #10     Jan 5, 2004