There's a fine line between being "the next big thing" and being "the next great thing. " The difference comes down to success. If a new idea...
There’s a fine line between being “the next big thing” and being “the next great thing.” The difference comes down to success. If a new idea can deliver performance, it will be both the next big thing and the next great thing.
But until some new concept proves itself, the “next big thing” is much more likely to be like Munder Small/Mid Cap 130/30 and RiverSource 130/30 US Equity, two issues from a new genre of ordinary mutual funds taking on hedge-fund-like strategies — and the latest pick as Stupid Investment of the Week.
Stupid Investment of the Week showcases the concerns and characteristics that make a security less than ideal for the average investor, and is written in the hope that spotlighting flawed thinking or execution in one case will help consumers avoid similar situations elsewhere.
While obviously not a purchase recommendation, neither is this column meant to be an automatic sell signal; people with the confidence in the 130/30 strategy — who jumped in to this burgeoning asset class early — might want to stick around in the funds to see if they can prove themselves in practice.
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To date, however, that has not happened, and the Munder fund (ticker MAMSX) and RiverSource (RUSAX) fund are poster children for why investors should be skeptical.
Before you can see why that is, however, you need to understand what a 130/30 fund is, and why there are now roughly 100 distinct funds following this strategy, with the vast majority of those funds — including Munder and RiverSource — less than a year old.
Some people avoid the confusing numbers by simply calling this new genre “hedge-funds lite,” while others call their versions “limited-shorting” or “enhanced alpha” funds.
The 130/30 moniker reflects what these funds do. Typically, a 130/30 fund invests 130 percent of its assets in “long positions” — stocks on which the manager is betting that the price is going up — and 30 percent in short positions, where the expectation is that the price will go down.
In a short sale, the seller borrows stock and sells it on the open market, getting the cash from the sale. If the stock’s share price falls, the investor buys back the shares at a lower price, returns them and pockets the difference.
The proceeds from those short sales create the extra 30 percent of long exposure. On a net basis, the extra long and the short position cancel out and the fund can claim to be “fully invested.” For the average investor, however, the idea is that the extra investment, theoretically, turbocharges returns.
In a traditional fund, the manager can put money only into stocks that appear headed for takeoff. In a 130/30 fund, the manager gets to put all of his information to work, betting on crash landings, too, a hedge that is particularly attractive in times like these, when the market is struggling the way it is right now.
It’s a different twist on long-short funds and market-neutral funds, both of which brought certain qualities of hedge funds — notably a purported ability to make money in all market conditions — to ordinary mutual funds. Alas, the vast majority of those fund types have failed to deliver on their potential; most market-neutral funds have been unable to make decent money in all market conditions.
So when consumers come face to face with a new type of fund type that can bet in all directions, there’s a logical expectation that it will deliver superior performance in all market conditions.
On that front, this column probably could have punished the entire genre of 130/30 funds. Early this year, Standard & Poor’s issued a research paper suggesting that the performance of 130/30 funds should be measured against traditional long-only benchmarks such as the Standard & Poor’s 500 index; in that race, most of the new funds have proven to be laggards.
So it is with Munder and RiverSource, two boutique shops that haven’t done anything to make investors believe they can actually deliver on the promise of the 130/30 formula. The two funds — which opened within 10 days of each other in October of 2007 — combine to show virtually all of the concerns an investor should have with the 130/30 asset class.
The Munder fund has attracted virtually nothing in assets, being so small that investment researcher Morningstar doesn’t even calculate its expense ratio. Fund-tracker Lipper pegs costs at 1.4 percent, or roughly the average for a stock fund; 130/30 funds typically have above-average costs and turnover, so holding the line on costs is a good sign.
But the fund itself has lost more than 14 percent this year, ranking it in the bottom 10 percent of the mid-cap blend peer group. Worse yet, the fund has moved in lockstep with the S&P 500, never zigging when the other zagged, just doing worse than the benchmarks.
For a fund that is supposed to be doing something different, the same movements but with extra volatility is a complete failure to deliver on its promise.
The RiverSource fund is off more than 17 percent year-to-date, ranking in the bottom 5 percent of the large-cap blend peer group. With $17 million in assets and an expense ratio of 1.5 percent, the fund has shown nothing in its short life that should lead anyone to believe that it will be the 130/30 fund to live up to the hype.
Steve Deutsch, director of separate accounts and collective investment trusts for Morningstar, has done extensive research on the new funds and says that consumers need to recognize the difference between the marketing hype and the real world, because the entire genre of funds remains unproven.
“There is a compelling marketing rationale — so you can understand why a fund company wants to do this — but from an investor’s perspective based on the real results seen so far, there is no compelling reason to choose 130/30s over other approaches,” Deutsch said. “They are trying to present this as a safer way of investing, as a way to make money — or lose less — in all market conditions, but the results just haven’t shown that.”
The Munder and RiverSource versions of 130/30 funds have shown that investors are better off waiting for “the next big thing” to prove itself than taking the test drive.
Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe’s Stupid Investment of the Week or a comment about this week’s column, you can reach him at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.