Wealth Manager

Bringing hedge funds to the masses is an idea that’s been
around for a while. But the results have been mixed when it
comes to delivering the hedge fund space writ large in one portfolio
that’s both affordable and representative of the alternative
funds world. Taking a fresh shot at the challenge is the four-yearold
Geronimo Financial, which specializes in privately managed
absolute-return investment strategies.

The Denver firm recently expanded into the world of mutual
funds, which is good news for investors who are looking for an
expansive definition of hedge funds in one package. Geronimo
Multi-Strategy is a noteworthy addition to the small but growing
niche of alternative investment mutual funds. Indeed, Geronimo
Multi-Strategy sets a new standard for advancing the concept of
democratizing hedge fund investments. The fund’s most impressive
feature is its diversification across eight broad hedge fund
strategies, each represented by dozens of existing hedge funds
chosen by HFR Inc. for its HFRX Equal Weighted Strategies Index,
an investable index-platform previously available only to institutional
investors. The fund also features:

* Low minimum investment of $1,000

* No net-worth accreditation hurdle for investors

* Daily liquidity and pricing

* Performance-based fee structure

* Daily monitoring and analysis by HFR of the managers in the index

It’s too soon to pass judgment on a fund with less than a year
of history, but Geronimo Multi-Strategy is clearly an intriguing
newcomer that could ultimately set a new standard for publicly
traded alternative investments. Indeed, others have tried to make
multi-strategy hedge fund investing more affordable and accessible,
but the growing pains have been considerable. For one notable
example of what has gone wrong, stir the ashes of the now-defunct
products tied to the S&P Hedge Fund Index. In June, Standard &
Poor’s stopped publishing the benchmark—a victim of the blowback
from Refco, the derivatives broker that collapsed last year.
As a result, products benchmarked to the S&P Hedge Fund Index
have been forced into early retirement, including the Rydex Sphinx
Fund, a publicly registered fund that succumbed.

Even among the new generation of hedge fund products that
are currently available, there’s plenty of grumbling about portfolio
design. In some cases, critics say that the manager choices are unimpressive, or that portfolios are relatively undiversified. In other
funds, they find liquidity to be limited, or that investors must be
relatively wealthy in order to buy shares.

Still, there are choices to consider, and they’re growing in number
and sophistication. Rydex, for instance, rolled over the remaining
Sphinx assets into the firm’s Absolute Return mutual fund,
a new quantitatively managed portfolio that replicates a mix of
hedge fund strategies with derivatives and various trading techniques.
In fact, there’s a lengthening list of mutual funds focused
on one or more hedge fund strategies, such as long/short and market-
neutral. According to Morningstar, 39 long/short mutual funds
were plying the investment waters at mid-point this year.

It would appear that Geronimo Multi-Strategy is just one more
addition to an already established field. But while launching a
“long/short” mutual fund is old hat these days, a closer look at the
Geronimo portfolio suggests that it’s a bit different after all. While
it remains to be seen if Geronimo satisfies as an investment in the
long run, it is a new yardstick for bringing multiple hedge fund
strategies to the masses in a single fund.

The fund’s architect is David Prokupek, CEO and CIO of Geronimo
Financial, which he founded in 2002. Most of the $350 million
under management at Geronimo Financial resides in privately
managed accounts, but Prokupek embraced a wider audience in
January when he launched three mutual funds: Geronimo Sector
Opportunity, a long/short fund; Geronimo Option & Income, a market-
neutral strategy; and Geronimo Multi-Strategy, which has the
broadest scope of the three.

Geronimo Multi-Strategy is essentially an enhanced hedge fund
index, with HFRX Equal Weighted Strategies Index (HFRX) serving
as the index and Prokupek’s management delivering any enhancement.
Prokupek, who was formerly president of the capital markets
group at investment bank Tucker Anthony Sutro, recognizes the
challenge of trying to second guess a broad-based multi-strategy
hedge fund index like HFRX. In deference to the risk, Geronimo
Multi-Strategy’s returns will be primarily driven by HFRX over
time, he says. His attempts to enhance the benchmark’s returns
will play a secondary role with manager and strategy selection.
For example, Prokupek explains that he may overweight certain
managers, or underweight a strategy, relative to the HFRX mix.
Prokupek can also adjust the fund’s allocation to HFRX overall,
depending on his outlook for hedge fund strategies.

The overall goal is producing so-called absolute returns by tapping
into the broad landscape of hedge fund strategies and tracking
or exceeding HRFX’s returns. Historically, the multi-hedge
fund universe has produced returns of roughly LIBOR plus 300 to
500 basis points, he says.

With so much riding on HFRX, the first order of business for assessing
Geronimo Multi-Strategy is reviewing its benchmark, which
equally weights among eight HFRX sub-indices, each targeting a particular
hedge fund strategy, such as convertible arbitrage, distressed
securities and relative value (see hedgefundresearch.com for details).
In all, some 80 managers are included in the HFRX index.

The ability to access HFRX’s manager lineup is a breakthrough
for a mutual fund, says Prokupek. Although there are competing
mutual funds that hold multiple hedge funds, Geronimo—courtesy
of HFRX—distinguishes itself by exposing assets to the performance
results born of dozens of managers. By contrast, Alpha
Multi Strategies—a competing mutual fund—recently was using
nine hedge fund managers as subadvisors. There’s nothing wrong
with that, Prokupek says, but it’s a different, more narrowly focused
approach, and shouldn’t be confused with Geronimo Multi-
Strategy’s grander ambitions.

In addition to quantity, Prokupek emphasizes the quality of the
hedge fund managers in the HFRX index. The Chicago-based HFR
is really two companies: HFR Inc. is the database and research
division; HFR Asset Management offers an investable hedge fund
index platform to institutional investors. Geronimo’s partnership
with HFR allows the Multi-Strategy Fund to tap into the returns
streams from dozens of hedge funds in an investable-index platform
designed for institutional investors.

Opening a portion of HFR’s platform to anyone, for a nominal
sum, is a considerable achievement in the annals of hedge fund
investing, says Bill Santos, senior managing director of business
development for HFR Asset Management. “The fact that you
now have the ability to access these 80 or so institutional-quality
hedge fund managers in a mutual fund structure, with daily
liquidity, with a $1,000 minimum, and no accreditation is big
news,” he adds.

However, the transmission of HFRX’s hedge fund returns to
Geronimo Multi-Strategy is a bit circuitous, coming by way of
swaps, or privately negotiated derivatives contracts. Geronimo
Multi-Strategy doesn’t invest in the HFRX funds directly. Ownership
of so many hedge funds would be problematic for a mutual
fund for a number of reasons, including liquidity constraints and
calculation of net asset values on a daily basis.

Geronimo gets around the obstacles with an innovative backoffice
strategy of tapping into HFR’s platform through the magic
of financial engineering. The fund receives the associated performance
of the index by way of total-return swaps. The bottom line:
Several financial firms contract to deliver the related gains or losses
to Geronimo’s fund. As of this past May 31, for example, 39 percent
of Geronimo Multi-Strategy’s net assets were in swaps issued by investment
banks IXIS Corporate & Investment and Barclays Capital.

By mutual fund standards, Geronimo Multi-Strategy doesn’t
come cheap, with a gross expense ratio that can rise to as much
as 3 percent for I class shares available to wealth managers. That
looks pricey if you consider that most of the domestic stock funds
in Morningstar’s database charge less than 2 percent. Then again,
Geronimo’s expense ratio is slightly below the 3.24 percent average
for Morningstar’s long/short fund category. And by hedge fund
standards, where 2-and-20 pricing is common (2 percent of assets
and 20 percent of any profits), Geronimo’s fees are a bargain.

Meanwhile, fans of incentive-based pricing will find reason to cheer
Geronimo Multi-Strategy’s dynamic fee system, which is one of the
more ambitious in the mutual fund world. The fund’s basic management
fee is 1.25 percent, but that can fluctuate, based on whether the
fund’s returns exceed the Merrill Lynch Three-Month Treasury Bill
Index over the preceding 12 months. The management fee will stay at
1.25 percent as long as the fund’s performance is within a band of plus
or minus 200 basis points of the Merrill Lynch T-Bill.

If performance rises above that 200-basis-point band, the fee
increases; if performance drops below the band, the fee drops.
Overall, the management fee can range from 0.25 percent to 2.25
percent, and so the gross expense ratio can vary from 1.0 percent
to 3.0 percent for the I class of shares after adding the fixed 0.75
percent “other expenses” component.

For investors who are convinced that owning a wide sampling of
hedge fund strategies is a worthwhile addition to an asset allocation
strategy, Geronimo Multi-Strategy promises to be a favorite.
The larger question is whether hedge funds will live up to the hype
in the long run and materially improve the risk-reward profile of a
traditional stock/bond/cash portfolio.

All the innovations in the world don’t change the fact that it’s
too early to make definitive conclusions about hedge fund performance
generally. The products have precious little performance
history for making the kind of sweeping judgments about the past
such as those dispensed in the name of equity and fixed-income
indices. Financial engineering continues to impress, as Geronimo
Multi-Strategy illustrates. But some questions about portfolio
strategy can only be answered with time. Even though it’s becoming
easier to own hedge funds, the jury is still out on the long-term
merits of hedge funds in context with other asset classes.