Money Management Executive
This summer's extreme market volatility was enough to make investors and mutual fund managers seasick.
For managers of long/short and market-neutral funds ? which according to Morningstar are a $21 billion slice of the mutual fund market ? the markets have been either painful or gratifying lately.
For those that are suffering the effects of the subprime mortgage industry's meltdown, which affected credit markets and scared equity investors away from a plunging equity market, are trying to recover.
Those whose funds have continued to perform well are gloating that their funds did exactly what they were intended to do: ride out the storm.
One fund group that did not ride it out is Geronimo Financial of Denver, which told shareholders on Aug. 21 that it would close its three mutual funds at the end of this month.
The three ? the $8 million Geronimo Multi-Strategy Fund, the $3 million Geronimo Sector Opportunity Fund, and the $4 million Geronimo Option and Income Fund ? have all posted negative performance year to date, according to Morningstar.
A call to Geronimo's top executive was not returned.
"You've gone through a period of time that got wacky," said Barry James, president of the James Advantage Funds. His company manages the $43 million James Market Neutral Fund, which made its debut in 1998 and is the second-oldest market-neutral fund in the market.
In two days in August, "hedge funds were in full panic mode and sold, sold, sold, making it an especially difficult time for some," Mr. James said. Those funds that base stock selections strictly on valuations were burned.
The James Market Neutral Fund, which has returned nearly 3% year to date, did well by staying true to its market-neutral position, said Brian Shepardson, one of the fund's team of managers.
"In theory it should work in all types of markets and have no style drift," he said. In addition, the fund doesn't use leverage, which can add to managers' woes.
TFS Capital in West Chester, Pa., acknowledged in an Aug. 31 letter to investors from the firm's portfolio managers that its mutual funds, including the $144 million TFS Market Neutral Fund, were performing poorly.
The market-neutral fund, however, clawed its way back into the black, its year-to-date performance up 2.09% through Sept. 11.
"It was a very difficult market to navigate through," said Rich Gates, co-portfolio manager of the fund. "When hedge funds closed out their positions, it hurt us."
TFS' managers noted in the letter that the fund had significant overlap with the positions hedge funds had been holding and were frantically selling out of in August. The managers promised to make adjustments that would reduce the likelihood of overlap with other quantitative managers in the future.
The silver lining is that the managers of those funds that suffered losses were able to pick the very same securities that the top hedge fund managers had picked, Mr. Gates said.
"The more skillful you are, the worse the returns," he said.
"This market has tested everyone's risk models and performance," said Guy Benstead, a partner with Cedar Ridge Partners in Greenwich, Conn., and co-portfolio manager of the $8.6 million Forward Long-Short Credit Analysis Fund that Cedar Ridge subadvises. The fund has the distinction of being the sole fixed-income fund in Morningstar's universe of long-short mutual funds.
The key determinant of who perished and who survived was the use of leverage, and the Forward fund has less than 1% leverage, Mr. Benstead said.
The fledgling Forward fund, which maintains long positions in municipal bonds, corporate and high-yield bonds, and preferred stocks, and shorts the Treasury, agencies, and corporate bond sectors, made its debut on Dec. 29, 2006, and was down 12.2% through the middle of this month.
The municipal market, which simply "came unglued" in July and August, was particularly hard hit by technical repricings of securities, Mr. Benstead said. Technical dislocations can and do happen, as was evidenced in 2005 after Hurricane Katrina and Hurricane Rita, he said.
The good news is that the market is starting to mend itself and risk premiums should stabilize, Mr. Benstead said.
Just over a year old, the Janus Adviser Long/Short Fund, from Janus Capital in Denver, held up extremely well, producing an enviable year-to-date performance of 13.64%.
Dan Kozlowski, one of the three portfolio managers for the Janus Capital fund, attributes the company's success to several things. "We did what we said we would do and had classic good stock picking on our short" positions, he said.
The fund is contrarian by nature. Managers seek out companies facing some kind of challenge or controversy or where other investors are "disinclined to play," Mr. Kozlowski said.
The fund is unconstrained, and can invest anywhere, both internationally and domestically, and within all market capitalizations, and uses options to reduce risk.
"We don't predict the direction of the market, so we're net long," Mr. Kozlowski said. The fund promises to its investors that it will be roughly 50% net long at all times.
The fund typically takes long positions in equity stocks with unrecognized value, undervalued growth, or those in special situations.
Offensively, it takes absolute short positions in stocks it believes are fundamentally undervalued, and relatively shorter positions in other equity holdings to hedge its longer holdings.
"This is an easy market to lose your discipline in," Mr. Kozlowski said. "If you're not hedged in up markets, you won't be hedged in down ones."
