Here’s an article about the relationship between hedge funds and ordinary mutual funds.
Posted on Tue, Nov. 07, 2006
Concern increases over ‘side-by-side’ managers
By Eleanor Laise
WALL STREET JOURNAL
A growing number of money managers are juggling multiple roles, handling plain-vanilla mutual funds for mom-and-pop investors as well as hedge funds for wealthy individuals and institutional investors.
Regulators and lawmakers have raised concerns about the trend, saying it could lead managers to favor deep-pocketed hedge-fund investors over the smaller fry investing in mutual funds. Some major fund companies, including Vanguard Group, staunchly defend these so-called “side-by-side” management arrangements. Others, such as Fidelity Investments, avoid the practice. Even new academic studies are divided on the issue of whether small investors are well-served by side-by-side management.
For fund companies, hedge funds — private investment pools for wealthy and institutional investors — can be much more lucrative than mutual funds.
Mutual funds now sharing managers with hedge funds include offerings from Vanguard, Pioneer Investment Management, Nationwide Mutual Insurance Co.’s Gartmore Global Investments and Ameriprise Financial Inc.’s RiverSource Investments. Such arrangements account for a small but growing slice of the fund universe, industry experts say. There are 124 individual portfolio managers simultaneously running mutual funds and hedge funds tracked by investment-research firm Morningstar Inc., compared with 112 last year and fewer than 60 in 2002. About $448 billion was invested in actively managed stock mutual funds run by companies that also managed hedge funds in 2004, according to Scott Gibson, an associate finance professor at the College of William & Mary’s Mason School of Business.
Many managers in recent years have left mutual-fund firms for the bigger paychecks and lighter regulation of the hedge fund world, and defenders of side-by-side management say that it helps mutual-fund companies retain talented employees and access a broad pool of top money managers. But critics say the practice gives managers an incentive to favor hedge funds with their best investment opportunities and distracts them from running their mutual funds.
A number of major fund companies steer clear of the practice. American Century Investments offers a traditional mutual fund that uses hedging strategies, and such funds “are a better deal for shareholders,” said Phillip Davidson, a senior vice president at the firm. Fund giant Fidelity has no in-house hedge funds and prohibits managers from running outside ones.
Other major players, however, defend side-by-side management. “It allows us to look at a very broad universe of managers and hire the best that we can find to run money for our shareholders,” said Joe Brennan, principal at Vanguard.
There are several ways that moonlighting managers can favor hedge funds over mutual funds. A manager might sell shares of a stock in his hedge fund before his mutual fund because he knows the sale could drive the price down. Instead of assigning a trade to a particular fund at the time it’s executed, a manager can “cherry pick” trades. He may make a trade in the morning and assign it to the hedge fund or mutual fund later in the day depending on its performance. And a manager who has access to a limited number of shares of a hot initial public offering might favor his hedge fund with them.
Shorting stocks, a strategy often used by hedge funds that typically involves selling borrowed shares with the hope of buying them back later at a lower price, can also lead to potential conflicts.
The SEC doesn’t dictate how managers should address these potential conflicts, and practices can vary widely among managers who run both hedge funds and mutual funds.
