Alternative Investing with Mutual Funds

Too many investors, mutual funds can be seen as stodgy old investment vehicles—they don’t appear to be nearly as exciting as options, futures, commodities, and hedge funds. However, the popularity of alternative investments as an asset class over the past decade has created a merger-of-sorts of the two styles: Alternative Investment Mutual Funds.

While there are currently over 500 funds in this category, the total assets under management remains small at just over $150 billion, barely over 1% of all mutual fund assets. These types of funds are able retain the traditional mutual fund structure while providing the average investor access to alternative investments, including currencies, merger arbitrage, and market neutral strategies.

One popular fund is the Merger Fund (MERFX), which manages over $4.5 billion in a merger arbitrage strategy. Merger arbitrage, a very common hedge fund strategy, attempts to profit by buying and selling shares of companies involved in pending mergers. The benefit to this type of strategy is similar to other funds that take a long-short approach: a low beta (a measure of the fund’s correlation with the market). MERFX, for example, has a beta of only 0.1, which will help in reducing the volatility of your portfolio while providing strategy diversification.

One alternative investment firm, Hatteras, has recently launched two new funds this year, both a dedicated Long/Short Equity Fund (HLSAX/HLSIX) and a Long/Short Debt Fund (HFIAX/HFINX). These funds allocate their assets to different hedge fund managers; for example, the HLSAX fund uses an institutional money manager to run the convertible arbitrage portion of the fund, while a Registered Investment Advisor manages the hedged high-yield strategy. In total, the Debt Fund has four sub-advisors, while the Equity Fund has six sub-advisors.

However, while alternative investment mutual funds may provide the average investor with unique, yet traditionally out-of-reach investment strategies, they typically charge much higher fees than the average mutual fund because of the active management and more complex strategies involved. For example, MERFX charges an expense ratio of approximately 1.4% – eight times larger than what Vanguard charges for its passive S&P 500 Index Fund (VFINX)! The Hatteras funds are even worse, charging between 2.5 – 3% per year.

However, not all alternative funds are that expensive; the Gabelli ABC AAA fund, which invests in treasuries, arbitrage, and value stocks has a beta of 0.17, yet only charges 0.64% per year. There are also funds that invest solely in hard assets and currencies, such as Permanent Portfolio (PRPFX) and Franklin Templeton Hard Currency (ICHHX), which give mutual funds investors exposure to these assets through a convenient mutual fund structure without worrying about the futures markets and more complex investment vehicles.

While an alternative investment strategy may not be for everyone, these alternative mutual funds make it possible for the average investor to take advantage of more complex and diversified strategies than they otherwise could.