Consumers often face a difficult decision choosing between two similar items -- both may possess attractive features. It's only natural, then, that the manufacturer of each product would try to adopt the best features of the other.
Such seems to be the case these days with mutual funds and hedge funds. Prospective investors in mutual funds are attracted to their easy access and greater stability, while longing for hedge fund-like returns. On the other side of the investment management aisle, potential hedge fund investors love the opportunity to achieve greater returns, while wishing the funds were on more sturdy technology footing. Thus, the two vehicles are beginning to look more and more like each other.
For example, Rockville, Md.-based Rydex Investments launched two mutual funds with hedge fund characteristics late last year. The Rydex Hedged Equity Fund ($25 million in assets under management) and the Absolute Return Strategies Fund ($51 million in assets under management) seek to offer hedge fund investment strategies with the liquidity and transparency of mutual funds. Stephen Sachs, director of trading with Rydex, says the fact that many hedge funds have been offering less-than-spectacular returns has provided an opening for mutual funds to enter that market. "There is a far greater percentage of hedge funds that are really just providing beta [as opposed to alpha returns]," he says. "They are all in the same trades, structuring the same kind of exposure and risk/return profiles."
The move to offer hedge fund-like products was not a stretch, according to Sachs, who explains that Rydex has been working with long/short stock baskets, long/short derivatives, and exchange-traded funds in the futures and options market and over-the-counter and swaps market. These investment strategies are based on a regression-analysis approach; with such practices in place, Sachs says, Rydex was well set up from a technology standpoint to execute and manage hedge fund strategies.
The portfolio managers who oversee those funds use a mix of vendor-based and homegrown systems, Sachs relates, including -- for portfolio modeling and research -- Optimizer for risk analysis and portfolio construction from Norwalk, Conn.-based FactSet and Northfield Information Services (Boston); and -- for market data -- Bloomberg and Reuters. The portfolio management process also is fed by "numerous" databases of earnings estimates and balance sheet information, including Standard and Poor's Compustat Data. "Then, within the portfolio management and research groups, there is some homegrown stuff, which effectively involves basic use of databases, and Excel [spreadsheets] and screening tools we have built to screen data," Sachs adds.
Arising from its research process, Rydex then has external models that consist of long/short stock baskets, futures allocations and fixed income allocations. Rydex's homegrown systems are used in the communication and handoff of those models from the portfolio management and research group to the trading group and, eventually, to the firm's back-end accounting system. On the trading side, Rydex uses REDIPlus and TradeFactory -- both owned by Spear, Leeds & Kellogg (New York), a division of Goldman Sachs Group -- for its order management systems, while the company uses FactSet's Marquee for market data, research and analytics.
When it comes to counterparties, Rydex keeps its circle small while using direct market access, algorithms, crossing networks, third-market relationships and wholesale relationships. Sachs says the firm also works with a few bulge-bracket firms. "We want to leverage the relationships we have by being a high-profile client, as opposed to doing business with 50 to 60 players on The Street," he says. To that end, Sachs continues, Rydex works with about 11 counterparties -- seven "with actual humans on the other end" and four electronic.