Thursday, March 01, 2001

Do Mutual Fund Stars Make for Leading Hedge Fund Managers?

Do Mutual Fund Stars Make for Leading Hedge Fund Managers?
Alternative Investment News
March 2001
By Pamela Appea

Star mutual fund managers, and even their lesser-known colleagues, have been leaving the industry in droves to become hedge fund managers. That’s for certain.

But what remains unclear is. Whether the skills that led to top mutual fund performance translate to hedge funds.

The ability of mutual managers to pick winning stocks, while certainly key, may not be enough when it comes to generating strong hedge fund performance, said hedge fund consultants and hedge fund managers.

Differences in asset management styles and organizational support and structure, particularly between the large mutual fund complexes and small boutique hedge funds, can raise hurdles to mutual fund managers in the hedge fund arena, they noted.

The managers are moving from a position where their main focus is stock picking to one where they are running a money management business, where they too have to draw on their asset management strategies but also deal with other aspects of the business.

The main challenges for those crossing over to hedge funds including shorting securities, asset gathering, setting up company infrastructure and development and dealing with investors who may be more focused on shorter-term performance than mutual fund investors, pointed out hedge fund managers and industry consultants.

Former mutual fund managers may face obstacles when they switch over to hedge funds, but that is not to say they cannot be successful, newly minted hedge fund managers are quick to add. Managers can bring skills including knowledge of the market and also a strong understanding of portfolio management, to hedge funds.

Consultants point to Jeff Vinik, former manager of Fidelity’s Investment’s Magellan Fund, as an example of a success story.

Vinik, who recently returned money to investors and handed over the reigns over the reigns as head of his hedge fund, opened Vinik Asset Management with $800 million in 1996. Vinik succeeded in growing assets to $4.2 billion--positing a return of 645.8% since inception.
Shorts Seen as Challenge

One of the major differences in investment styles between mutual funds and hedge funs is the ability to short stocks. Mutual funds can take short positions, but most do not in any significant way. Playing the downside of the market is different, while related, to playing the upside. For one, the time window in which a stock needs to depreciate for a short position to be profitable can be smaller than the one needed for a long position to appreciate.

“The hardest thing to do in all of finance is to short stocks,” said Hunt Taylor, director of investments of Stern Investment Holdings, the investment arm of the Hartz Group, based in Secaucus, N.J. Additionally, there is no cap on how much a security can rise. But a security can only fall 100%, Taylor added, and that can be a significant adjustment for cross-over managers.

Former Loomis Sayles mutual fund manager Jerry Castellini, founder of Chicago-based CastleArk Management, agrees. He said switching from long-only to the lon/short model was difficult. But at the same time, Castellini said, hedge fund managers can often focus on honing a narrow strategy more than mutual fund managers can. This gives the hedge fund managers the ability to spend more time evaluating securities so they can play the downside.

Both of CastleArk’s hedge funds have had above-average returns: Its diversified hedge fund had a 65% annual return-after expenses in 2000, and its energy hedge fund was up 66% after expenses last year.

Building Infrastructure Presents Hurdle

Sometimes the highest hurdle to surmount is not adjusting to differences in asset strategy but dealing with what can often be a far less support, especially in areas such as capital raising. It can be a disconcerting adjustment for a mutual fund managers coming from a big-name complex to a small hedge fund shop, said Richard Lake, a consultant for Greenwich, Connecticut-based Lake Partners.

Making up for the lack of resources can be an enormous challenge, he explained. The amount of seed capital with which a hedge fund launches can be a strong factor in which makes or breaks a new shop, said CastleArk’s Castellini. Managers who spend large tracks of time raising money may do so at the expense of focusing on the fund strategy, Castellini noted, adding CastleArk raised $700 million in its first year, comprised of both hedge fund and mutual fund assets.

Star mutual fund managers may be more likely to attract former clients and new money based on name recognition while others with smaller profiles might have a more difficult time, he said.

Building firm infrastructure, which includes such things as hiring skilled people or getting used to new accounting system, also presents challenges to new hedge fund market entrants.

Michael Lipper, a pioneer in the mutual fund arena, and president of Lipper Advisory Services based in Summit, New Jersey, said without infrastructure, a cross-over mutual fund manager can have a difficult time, especially if they hail from a prestigious mutual fund company.

Lipper, co-founder of a new hedge fund that currently has $17 million in assets under management, is working on growing the fund.

Hedge fund investors themselves also present challenges that mutual fund investors do not in that the hedge fund investors are often more focused on shorter-term performance.

As former Monument Internet Fund manager Alex Cheung noted, mutual fund investors often judge performance by short-term profits and returns.

Mutual fund investors might look at performance once every three months while institutions want more updates, added Chung, now managing director of King of Prussia-based hedge fund shop Long Bow Capital Management, a technology long/short fund shop.

Cheung declined to divulge how much Long Bow has in assets under management or performance information. He did say the new firm hopes to show profit in six to 12 months.

The jury is still out on how these cross-over managers will do. Over the next year, market players will be watching to see who wins and who loses.