Sub-Prime Returns Redux

Some Mutual Fund Hit Hard, Too

Many of the open-end mutual funds that use hedging strategies, especially those with the term "market neutral" in their names, had problems as well. Some were down over 10% in a span of four days. Hardly any of these funds employ leverage, but many had to unwind nevertheless, due to a wave of mid-month redemptions from skittish investors who had not thought such a precipitous drop was possible in a hedged portfolio, or due to quant models triggering sell signals.

In the aftermath, strategy diversification of fund-of-funds and some multi-strategy approaches did well to mitigate exposure. But in the hedged mutual fund space, there are very few funds that are more than just one manager and/or one strategy. Lee Schultheis, manager of the longest tenured of the multistrategy funds, AIP's $600 million Alpha Hedged Strategies Fund (ALPHX), noted that "our in-flows grew to a record of $78 million in August, primarily due to the problems experienced by our single-strategy peers." The fund was down only 0.07% in August and was still up 6.00% YTD.

Helping to avoid a big mid-month drawdown was the fund's broad array of strategies, with 22 active managers running a diverse mix of styles including long/short equity, fixed-income arbitrage, distressed securities, and others. Even the subprime woes were put to good use as Schultheis noted "we were positioned slightly net short with respect to subprime in our fixed-income arbitrage strategy, and that subaccount actually was up almost 10% in August. But the key to being highly diversified and consistent, especially when the markets are tumultuous, is to not take large net exposures, and keep a broad mix of strategies active at all times."

Schultheis's fund is the No. 1 Lipper Equity Market Neutral Fund for the last three years as of August 31, 2007, and will reach the five-year mark this month.