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Nov. 14, 2010, 11:15 p.m. EST

Mutual Funds From the 'Hedge'

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By Alistair Barr & Sam Mamudi

In the late 1990s, Stephen Roseman had a whiteboard in his office to keep track of all the companies in the nascent video-on-demand sector.

But for all the hype, it would be years before video on demand would become widely adopted. These days, said Mr. Roseman, many people can barely remember life without the technology.

This anecdote is how Mr. Roseman explains why he left the hedge-fund world to start a hedged mutual fund. While talk of using alternative strategies in mutual funds raged for years without much happening, it is now beginning to take off.

"We're at the very early stages of a multitrillion-dollar wave that's going to wash over the long-only asset-management industry," said Charles Krusen of Krusen Capital Management LLC, which has invested in hedge funds, including Paulson & Co., Moore Capital Management and D.E. Shaw & Co.

Hedged mutual funds provide stock-like returns with less volatility. Moreover, they provide more transparency and regulation than hedge funds. "We think there'll be a huge move to these types of funds," Mr. Krusen said.

Mr. Roseman, chief executive of New York-based Thesis Fund Management LLC, oversaw about $2 billion in assets at hedge-fund firm Kern Capital Management LLC between 2003 and 2005. This year, he launched a mutual fund called Thesis Flexible Fund (trading symbol: TFLEX). Flexible Fund is down 0.4% from its March launch to Thursday's close, according to Morningstar. In that time, the S&P 500 is up 10%.

He isn't the first hedge-fund manager to do this. AQR Capital Management LLC, co-founded by Clifford Asness , raised more than $1 billion in less than a year after launching several mutual funds last year.

Mr. Roseman reckons he is at the vanguard of a movement that will see more managers take their trading skills to the retail-investing arena.

"It's not that people don't want the strategy," he said, "it's that they don't want the hedge-fund structure."

Hedge funds take short positions, bets on falling prices, as well as long positions that benefit from rising valuations. They also can use borrowed money, or leverage, to magnify returns. They usually lock up investor money for a quarter or more, and some are free to trade any securities or derivatives anywhere in the world.

The goal is to generate positive returns, irrespective of the direction of the overall market. This is usually all wrapped up in a limited-partnership structure in which the manager charges an annual fee of 2% or so and takes about 20% of profits each year.

Traditional mutual funds typically take long-only positions and try to beat benchmarks, such as the S&P 500-stock index. The average net expense ratio of mutual funds is about 1.3%, according to Morningstar. Mutual funds don't take any cuts of profits. In contrast, the Flexible Fund's net expense ratio is 3%, according to Morningstar.

Goldman Sachs Group /zigman2/quotes/209237603/composite GS +0.16% Inc., one of the largest hedge-fund managers in the world, advised investors to add this new breed of mutual fund to their portfolios in a September report.

Brad Alford , who invested in hedge funds for more than two decades for institutions, including Duke University's endowment, is a convert to hedged mutual funds. Mr. Alford is chief investment officer of Alpha Capital Management, offers managed accounts that invest in several large hedged mutual funds. His picks include BlackRock Global Allocation /zigman2/quotes/205546109/realtime MALOX +0.83% fund (MALOX), Pimco All Asset All Authority /zigman2/quotes/205609764/realtime PAUIX +1.02% fund (PAUIX) and Ivy Asset Strategy /zigman2/quotes/200116034/realtime IVAEX +0.93% (IVAEX). "There are so many great mutual funds that look like hedge funds now," Mr. Alford said.

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