'Funds of funds' tame market swings

A kind of group thinking has long prevailed in the mutual-fund industry, many experts agree. And for years, that has led to a uniformity of stock-fund underperformance.

Mutual Funds Quarterly July 7, 2003 Ready for liftoff? 'Funds of funds' tame market swings Junk-bond chasers eye yields, downplay risk

Get all the Monitor's headlines by e-mail. Subscribe for free.

E-mail a friend Print this Letter to the Editor Republish E-mail newsletters RSS

A fast 1990s economy was forgiving. And the current market updraft - however long it endures - is again lifting stock funds across a wide spectrum.

But while equity funds became the highway to profits during the bull market, most lost money rapidly when the bull turned into a bear.

There have been exceptions, in the form of funds content to produce regular, positive returns rather than ride rallies and slide into troughs. (Some have also shown an ability to outperform the Standard & Poor's index fairly consistently over time.)

Consider the FundX newsletter and the related FundX fund. The independent Hulbert Financial Digest ranks the newsletter No. 1 for 20-year performance and No. 2 for 5-, 10-, and 15-year performance.

The FundX fund's first full year of operation was 2002. For the year, it was down 14 percent. Notably, though, it outperformed both the S&P 500 and most of its competition by 9.2 percent.

For 2003, it's up 7.1 percent, exactly in line with the S&P 500.

The FundX strategy is straightforward: It holds a portfolio of the best- performing mutual funds. The portfolio is continuously upgraded, lagging funds replaced with better-performing funds.

"We monitor and average funds' one-, three-, six-, and 12-month returns," says Janet Brown, the fund's manager.

Whereas most mutual funds invest according to a particular style (say, value or growth) or favor a certain size stock (small-, mid-, or large-cap), the FundX approach allows it to adjust incrementally to whatever style or size is working best at the time, notes Ms. Brown.

While the strategy has performed well over time through varying market conditions, investors should note that the fund can lose money - and that it has higher-than-average fees.

Borrowing hedge-fund tactics

An even newer entry into the mutual-fund race is the Alpha Strategies 1 fund, a fund dedicated to achieving consistent absolute returns - whether the market moves up, down, or sideways.

The fund, run by Steve Samson and Lee Schultheis, employs a range of complex strategies that traditionally have been used by conservative hedge "funds of funds."

Hedge funds - in which partnerships of investors pool large sums of money and engage in often high-risk speculation - are typically available only to wealthy investors. But this mutual fund is making some of the more conservative tactics employed by managers of such funds available to average investors.

Combining disparate strategies in a way that doesn't let one negate the effects of another "results in a very conservative kind of portfolio in which each of these strategies is uncorrelated with each other and uncorrelated with the market," says Steve Samson, the fund company's chief executive officer.

The results so far indicate that the fund is achieving its main goal of stability over time. A "beta" (an industry measure of sensitivity to market movement) of -.02 reflects almost perfect market neutrality. And its "standard deviation" (a measure of volatility) of 3 reflects a level of volatility only one-fifth of that of the S&P 500.

For the year to date, the fund is up about 2 percent, and lags the market by roughly 5 percent.

"Over the past 13 years, there have been three periods of about a year in duration each [during which] it's been unfavorable for these styles," says Mr. Schultheis, the chief investment officer.

Sliding, but sideways

Still, even during such unfavorable periods, his fund tends "to go sideways, as opposed to going down like the equity long-only funds do," he adds.

Data from Hedge Fund Research, Inc., an industry-analysis group, backs up Schultheis's statement, and suggests that over those past 13 years, returns from funds using similar market-neutral approaches have averaged 9 percent to 10 percent per year after fees, with far less volatility than the stock market.

As in most cases when thinking apart from the norm is required, fees on this fund, too, are higher than the norm by about 1-1/2 percent, reflecting the use of several subadvisers with hedge-fund strategy expertise.

Also, investors should expect the fund to lag the major indexes during big rallies.