‘Long-Only’ Funds Lose Their Hedge’Long-Only’ Funds Lose Their Hedge

‘Long-Only’ Funds Lose Their Hedge’Long-Only’ Funds Lose Their Hedge

JULIET CHUNG

Nov. 10, 2013 7:02 p.m. ET

What do you call a hedge fund that doesn’t hedge? The latest growth area for the industry. On the heels of a multiyear market rally, a slew of hedge-fund firms are launching “long-only” funds betting that at least some stocks have further to climb. The moves come amid a brutal stretch for short bets against companies, traditionally a key strategy for hedge funds.The new funds also represent a shift by hedge-fund managers—known for their sophisticated tactics and exclusivity—into the kind of old-fashioned stock picking more associated with Main Street mutual funds.

But some wonder if the latest craze is merely a grab for fees, or perhaps even a sign of the top of the stock market.

The new entrants to the field include several firms with ties to Julian Robertson’s investment firm Tiger Management, including Tiger Global Management and Coatue Management. Tiger Management-backed Hound Partners is planning to launch one of its own next year, according to people familiar with the firm.

Craig McBeth, a protégé of Todd Combs, a former hedge-fund manager handpicked byWarren Buffett to help manage his company’s investments, left Berkshire Hathaway Inc.BRKB +1.80% this year to launch a fund that will make bets on a handful of companies. “We anticipate short positions will be rare: we believe they are inherently inferior to our best long ideas,” said a marketing document for Mr. McBeth’s new Judson Founders Fund that was viewed by The Wall Street Journal.

Other managers are considering similar plans.

“We’re seeing a big movement and we think it’s going to continue,” said Joseph Larucci of Aksia, a hedge-fund consultant to institutional investors such as pension funds. He said the launches are being driven largely by demand from investors as they look to replace some of their underperforming mutual-fund and traditional long-only managers.

Most stock hedge funds are designed to outperform in downturns but underperform in bull markets. But investors can get antsy after years of watching their high-priced hedge-fund managers lag the broader market.

Hedge funds investing in stocks gained 11.3% through October, on average, compared to 25.3% by the S&P 500 index, including dividends, according to data tracker HFR.

Long-only funds typically replicate bets on companies held by the firms’ main hedge funds, though they might hold fewer stocks or hold onto them for longer periods. In exchange, investors pay lower fees than for the managers’ hedge funds—though they still far outstrip fees for actively managed mutual funds.

Hedge funds have historically charged investors about 2% of assets under management and taken around 20% of the investment profits, an arrangement known as “two and 20,” though that model has come under pressure recently.

Actively managed stock mutual funds charge investors an expense ratio of 1.4% on average, according to Morningstar Inc., and don’t take a percentage of the profits.

The spurt of launches is raising some eyebrows, with skeptics—including hedge-fund managers not launching such products—saying the new funds are late to the party.

Indeed, short seller Bill Fleckenstein, who closed down his short-only fund in early 2009 after notching big gains in the 2008 financial crisis, is preparing to launch a new short-only fund early next year. He hopes to amass a war chest to deploy for what he expects will be a sharp market correction. “It happened in early 2000…it happened in [2007], and it’ll happen again,” Mr. Fleckenstein said.

Bruce Zimmerman, chief executive of the $30 billion University of Texas Investment Management Co., was among the first big investors to push hedge funds for long-only options about five years ago.

He said these funds can still make sense for investors, but that would-be buyers should figure out whether the products are a grab for assets and fees, or display a thoughtful approach focused on generating profits for investors.

“You know, it’s kind of human nature to chase after what’s hot,” Mr. Zimmerman said. “But if you’re going to make money, you want to buy low—which means buying what no one else is buying.”

Some of the long-only funds are finding plenty of takers.

Chase Coleman’s $12.5 billion Tiger Global, which runs both hedge and private-equity funds and made early investments in tech companies including Facebook Inc. FB -0.06%and LinkedIn Corp. LNKD +1.75% , has already amassed $1.3 billion in its long-only fund which launched Oct. 1, according to people familiar with the matter.

The fund charges slightly lower fees than the “two and 20” collected by the flagship stock hedge fund. Through October, Tiger Global’s flagship hedge fund was up 8.3% after fees, hurt by its short bets. The long-only fund has been in the works for more than a year, a person familiar with the firm said.

Philippe Laffont’s $8 billion Coatue launched a long-only fund in May that offers investors part of his flagship hedge fund’s portfolio, also for lower fees.

Mr. McBeth, 32 years old, who had worked for Berkshire’s Mr. Combs since 2006, plans to charge investors in his Stamford, Conn., fund a 1% management fee and 25% performance fee—the latter being collected when the fund performs above a certain point—to buy and hold a small group of stocks, according to the marketing document.

Mr. McBeth joined Mr. Combs at Berkshire after Mr. Buffett plucked Mr. Combs from relative obscurity in 2010 to oversee part of Berkshire’s investment portfolio.