GO
Loading...

Sackler family makes $100M bet on low hedge fund fees

Monday, 6 Jan 2014 | 7:00 AM ET
Choosing to manage hedge funds over mutual funds
Monday, 6 Jan 2014 | 11:00 AM ET
CNBC.com enterprise reporter Lawrence Delevingne explains why hedge fund managers usually make much more money than their mutual fund counterparts--and how that could change if enough switch over.

The promise of fast-growing alternative mutual funds is a hedge fund investor's dream: high returns and loss protection without paying exorbitantly high fees, locking up capital for a year or more, and barely understanding what the manager is buying and selling.

Still, a stigma has been attached to the funds, which either replicate hedge fund strategies or allocate to a group of hedge fund managers.

Why would a hotshot firm take public money for a fee of just 2 or 3 percent when it can also charge a performance fee of 20 percent in the private market?

That perception of negative selection bias got a stiff rejection last week, when a large family office well-versed in hedge fund investing pulled about half of its cash—$100 million—from its stable of equity hedge managers and put it in a new alternative mutual fund for a minimum of seven years.

Summer Road, the New York-based family office that manages part of the Sackler family pharmaceutical fortune, is all the initial money behind the Balter Long/Short Equity Fund, a $100 million offering launched Wednesday.

The new fund is controlled by longtime Boston-based hedge fund investor Brad Balter of the $1.2 billion Balter Capital Management.

"We've analyzed the equity long/short space pretty carefully, and the lack of consistency of returns coupled with very high fees led us to conclude that the alternative mutual fund product type was a superior vehicle," said David Sackler, president of Summer Road and grandson of Purdue Pharma co-chairman and philanthropist Raymond Sackler. "It's just a better mousetrap."

(Read more: Investors turn toward liquid alternative funds)

Sackler isn't the only one allocating to so-called liquid alternatives. Assets in 411 mutual funds in the category surged to $132 billion from $91 billion in 2013, according to Morningstar. That's up from 213 funds with $36 billion at the end of 2008.

"The growth is here to stay," said Josh Charney, an alternative investments analyst with Morningstar.

The new Balter fund aims to address the two traditional knocks on retail alternatives: the negative selection bias of managers desperate for money and a diluted version of the actual investment strategy to fit mutual fund rules on leverage, liquidity and transparency.

Balter's two managers so far, Daniel Barker's Apis Capital Advisors and David Cohen and Ross DeMont's Midwood Capital Management, have produced years of strong returns and will use the same long and short stock-picking strategy that they employ in their traditional hedge funds.

Apis's main fund, which will stay open, has averaged 9 percent annual returns net of fees since launching in April 2004, compared with 4.88 percent for the S&P 500 Index over the same period. Midwood has averaged 10.66 percent since December 2003, beating an index return of 5.48 percent. Both have made money every calendar year except 2008.

Despite those returns, both shops manage less than $100 million, a traditional benchmark for the financial health of hedge fund firms. Both charge performance and management fees of 1.5 percent and 20 percent, respectively.

Balter will use up to five hedge funds with a similar need for additional assets. That will keep the new fund of funds' costs down. It charges fees of just 2.19 percent or 2.54 percent, depending on the share class.

"This is a monumental change toward giving investors real hedge fund strategies in a mutual fund structure," Balter said, referring to how multimanager mutual funds have evolved away from mediocre managers using altered strategies.

(Read more: Is a hedge fund in your future?)

Vehicles that invest in existing hedge funds are a growing minority in alternative mutual funds.

There are about 30 today and have been boosted by recent launches in the space, including the Franklin K2 Alternative Strategies Fund, the Goldman Sachs Multi-Manager Alternatives Fund, and the Blackstone Alternative Multi-Manager Fund, a partnership with Fidelity.

Hedge fund firms that have launched modified versions of their strategies in a mutual fund format include AQR Capital Management, Avenue Capital Group, Whitebox Advisors and Visium Asset Management.

Overall, the largest alternative mutual funds are managed by John Hancock ($4.6 billion); Absolute Investment Advisers ($3.2 billion) and Natixis ($2.4 billion).

Fees for alternative mutual funds are usually about 2 percent. That's far lower that the mean management and performance fees for hedge funds of 1.66 percent and 19.15 percent, according to hedge fund data and news provider Absolute Return.

Traditional funds of hedge funds are even more expensive, usually adding on 1 percent and 10 percent management and performance fees on top of what's charged by the underlying managers.

The big question, of course, is performance.

For equity-focused managers—an area many see as ripe for conversion to public funds—the average alternative mutual fund gained 14.62 percent in 2013, according to Morningstar. That's lower than the S&P 500 index gain of about 30 percent but better than the Absolute Return U.S. Equity Index, which gained 12.66 through November (December returns were unavailable).

(Read more: Gottex readies fund to let Main Street invest like Wall Street)

Performance has been weaker over the last three years, with the average long/short equity mutual fund producing annualized returns of 5.74 percent and the average multistrategy liquid alternatives fund gaining 2.22 percent, according to Morningstar.

Managed futures-focused liquid alternatives that trade commodities and other assets have performed poorly over the last five years, declining an average of 4.81 percent.

McKinsey & Co. recently downsized its forecast for industry growth in part because of the problems with commodity funds. The consulting firm estimates that retail alternatives will control between 8 percent and 10 percent of $15.9 trillion in all mutual funds by 2017, according to materials provided to CNBC.com.

The projection had been for a 13 percent share of $13.3 trillion by 2015 in a Sept. 2012 report.

"Growth has continued to be strong across retail alternative asset classes, with the one exception being commodities," McKinsey told CNBC.com in a statement.

—By CNBC's Lawrence Delevingne. Follow him on Twitter @ldelevingne.

  Price   Change %Change
GS
---
BX
---
S&P 500
---

Featured

NetNet TV

Wall Street