Rising profile of hybrid funds

26Feb06

Angela Pruitt in the Wall Street Journal reports on the rising profile of so-called hybrid funds. That is funds that utilize hedge fund-like strategies. We have been chronicling the increasing popularity of these funds for some time.

Once challenge of hybrid funds and the rise of more flexible mandates is that it makes the once revered notion of equity style boxes problematic. This may have lead Morningstar to create a new catgegory for long-short equity funds.

The hope for the promoters of hybrid funds is the ability to generate funds with a better risk/return tradeoff. However in practice hybrid funds have not been altogether perfect. Pruitt notes the downside of these strategies:

While long-short funds may sound appealing, they are not without drawbacks. Some long-short funds have been disappointing performers. Fees typically are higher than for ordinary stock funds. Complex strategies can be difficult to understand.

In addition, the article notes that long-short funds usually have higher turnover which can beget higher short-term capital gains taxes.

Although Morningstar’s step has garnered hybrid funds greater attention that it is not without some trepidation.

At Morningstar in Chicago, Dan McNeela, an associate director of fund analysis, says the firm’s decision to create a separate category for long-short mutual funds may bring added exposure but is not an endorsement of the product.

“These strategies aren’t easy to execute. I think the fact that they have high fees has been a limitation,” he says. He notes that the performance of these funds hasn’t been stellar and that many are small and haven’t been able to attract a lot of assets.

For the time being hybrid funds are garnering a great deal of attention from fund companies that are launching new funds. These firms will need to help push educational efforts to help individual investors get comfortable with their portfolio management processes. On the upside another investment option is always welcome.