Welcome, AQR. Seriously.
Welcome to the most exciting and important marketplace since the hedge fund revolution began with Alfred Winslow Jones 50years ago.
And congratulations on your first mutual fund.
Putting real investment power in the hands of the individual is already improving the way people invest, think, build portfolios, and will spend their retirement years.
Financial literacy is fast becoming as fundamental a skill as reading and writing.
When we launched the first event-driven mutual fund, we estimated that millions of investors worldwide could justify the investment in alternative strategies, if only they understood the benefits.
Next year alone, we project that many more will come to that understanding. Over the next decade, the growth of alternative strategies mutual funds will continue in logarithmic leaps.
We look forward to responsible competition in the massive effort to distribute these strategies to the investment world.
And we appreciate the magnitude of your commitment. Because what we are doing is increasing financial capital by reducing portfolio volatility.
Welcome to the task.
Cliff Asness’ AQR gathered some press when it launched a mutual fund earlier this year. It has since been followed by Permal, which runs a tactical allocation fund under Legg Mason’s umbrella, and GLG with a U.K.-based retail fund. So the move by hedge fund managers to mutate from performance generators to classic asset gatherers is in full swing.
One of the absurdities of the hedge fund bubble is how little emphasis was put on longevity, and how pedigree came to replace longevity as a predictor of success. Anyone who has been in the investment business for some time knows that longevity is the most important predictor of long-term success. If pedigree were important, then George Soros should have never gotten anywhere: he started his career as a traveling salesman in Wales. Longevity will get you Morningstar and Lipper ratings, and AQR will have to wait three years to get there. Which shows that there is such a thing as an early mover advantage in mutual funds.
It is unfortunate that it is completely lost on most commentators that these hedgies are not the first mutual funds running hedge fund strategies. There has been a sizable minority of mutual funds that has managed alternative strategies for years, including yours truly. And what seems also lost on commentators is that the expense ratios of all these funds – between 1.50% and 2.0% – are well below those of typical hedge funds. Management fees alone run 2% in a hedge fund, and other expenses come on top. Not to mention the performance fee. A typical hedge fund has a 2.3% expense ratio plus a 20% performance fee. So a fixed expense ratio of less than two percent is a real bargain and evidence that the market for raising hedge funds is pretty much saturated, so hedge fund managers seek growth from lower-margin products. Commentators should stop calling mutual funds with alternative strategies “expensive”. They are bargains compared to hedge funds.
So let’s look briefly at the portfolio of the AQR Diversified Arbitrage Fund ADANX. It has almost half of its assets in SPACs. For readers unfamiliar with this acronym, we have written about SPAC arbitrage elsewhere in this space before. The problem is that the opportunities in SPACs existed mostly last fall, when we (or rather, our event-driven fund PAEDX) first got involved with them; by the beginning of this year, when AQR’s fund became active, they had disappeared for the most part. At the moment, we don’t expect much return from the SPACs held by AQR. The following table shows a list of annualized returns that can be achieved from the SPACs that AQR’s fund held on March 31st:With these annualized returns on half of the fund’s assets, we would not expect any stellar returns, especially not after deduction of the 1.5% expense ratio. We think that they hold SPACs mostly as a marketing gimmick, as they have received quite a bit of press lately. The other large positions in the portfolio are mostly convertible bonds. We did not see any merger arbitrage positions among the top 25 holdings, although that is the specialty of two of the four managers, Todd Pulvino and Mark Mitchell.
So again, we welcome AQR, GLG and Permal to the mutual fund world. We welcome you to your transformation to asset gatherers. We wish you all the best with not cannibalizing your high cost hedge funds. And any other hedge fund manager who wants to follow the lead of AQR and launch a mutual fund with an alternative strategy, give us a call. We have been running one for more than five years, and got the star rating to prove it.
Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which engages in merger arbitrage, capital structure arbitrage, proxy fight and distressed securities investments. He is the author of an e-book about alternative strategies as well as the forthcoming book Merger Arbitrage: How to Profit from Event-Driven Arbitrage (Wiley Finance, 2009).