Can a collection of mutual funds deliver the same or better performance than hedge funds and with much less risk? Alpha Capital Management’s Brad Alford seems to think so. He recently launched two of what he calls hedged mutual funds — which are really funds of mutual funds — that he asserts provide access to hedge‐fund like strategies with the fee structure, daily liquidity, and regulatory requirements of mutual funds.
Alpha Defensive Growth (ACDEX) seeks high, single-digit returns with downside protection. Alpha Opportunistic Growth (ACOPX) seeks equity-like returns with lower volatility.
Alford, however, is not some marketing spin-meister for a mutual fund firm. Rather, he has spent more than 20 years involved with hedge funds. He founded Alpha Capital Management in July 2006, which works with both traditional and alternative investment managers.
Earlier in the decade as the Director of Investment Advisory Services at MyCFO, Alford ran the Alternative Investment Committee and led the development of the alternative investment offerings for clients.
From 1995 to 2000, Alford was the Managing Director of the investment division for the $2 billion Duke Endowment, where he expanded the alternative asset portfolio from $100 million to more than $1 billion, investing in hedge funds, venture capital, leveraged buyouts, and other alternative investments.
So, Alford is very familiar with hedge funds, including their shortcomings. He has strong memories of the 2008 global economic and stock market meltdown, when many hedge funds with so-called absolute return strategies lost 20 percent, 30 percent, 40 percent and more for their investors, erected gates to prevent investors from redeeming their stakes, and created side pockets for their illiquid investments that amounted to much more than they — and especially their investors — thought they owned. “After 2008, the bloom came off the rose for hedge funds,” says Alford. “There are a lot of great managers running mutual funds who do what hedge funds do.”
With his new funds, like many hedge funds, Alford will make a macro assessment of investment strategies. He will seek managers who invest across the capital structure and deliver attractive returns of the strategy while minimizing drawdowns, weight individual managers based on correlations and their respective risk adjusted contribution to the portfolio and actively monitor and manage the portfolio.
Alford currently has identified about 21 managers who meet his strict criteria — and has placed 10 of them in one fund and 11 in the other. Keep in mind that Alford has been executing these strategies for clients for two years in separate accounts. Each of the two funds’ portfolios uses institutional mutual funds, ETFs and closed-end funds.
The Defensive Growth fund portfolio includes fixed income and hedge fund strategies such as market-neutral, global macro, and arbitrage and aims to produce returns of 7 percent to 9 percent over a full market cycle, while providing protection against losses similar to the protection provided by the Barclays U.S. Aggregate Bond and HFRI Hedge Fund of Funds Indexes.
His separate accounts had a Sharpe Ratio of 2.21 versus 1.53 for the HFRI Fund of Funds Composite. He used managers from firms such as PIMCO, JP Morgan, TFS, Eaton Vance, Payden & Rygel, State Street, Hotchkis & Wiley and Templeton.
The Opportunistic Growth portfolio includes long and short equity strategies, global equity and fixed income strategies with flexible mandates and the ability to short equities. The strategy aims to produce returns similar to the S&P 500 Index over a full market cycle, while providing near-term protection against losses similar in magnitude to those of the S&P 500 Index. Managers include Fairholme, Tradewinds, Yacktman, PIMCO, Federated, Ivy, First Pacific Advisors, and Pacific Heights.
Alford also figures to have an annual turnover of managers of about 20 percent. Afterall, he can dump a fund and buy a new one within 24 hours, compared to funds of funds, which must give 30 or 60 days notice to the manager, on average.
Why does Alford think he has a good product? Well, he has calculated that the current roster of managers in his Defensive fund outperformed the Barclays Aggregate Bond Index for six of the past eight years while the Opportunistic Growth fund has beaten the S&P 500 in five of the past eight years. More significantly, Opportunistic Growth performed in line with the S&P 500 during bull markets going back to 2000 but way outperformed during bear markets.
Alford says his funds offer another advantage — lower fees. He only charges 65 basis points above what the underlying managers charge and the managers do not charge a performance fee. Funds of hedge funds typically charge a 1 percent management fee and 10 percent performance fee over the underlying funds fees, which could be as high as 2 percent and 20 percent (although funds of funds typically get fee breaks). So, Alford figures the first 6 percent or so of a hedge fund of fund investor’s capital goes to fees.
So, is Alford, who has made money in part from investing in hedge funds, repudiating the asset class? No. Rather, he says he will place investors in either funds of hedge funds or long only exchange traded funds. He adds: “If we can provide the same or better returns than hedge funds with daily liquidity and no leverage, our clients will be happy.”
With hedge fund returns coming down for the past few years and with some managers cutting their fees in the face of sizable redemptions, it will be interesting to watch and see whether Alford can meet this goal. If so, his approach could become a lower cost threat to established hedge funds.
