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A Wolf in Sheep’s Clothing – a Hedge Fund Cloaked within a Traditional Investment Manager

Did you ever wonder who is sitting across the table from you at investor meetings? Would you be surprised to know that hedge fund investors could be sitting right along-side traditional long-only investors? In today’s complex and competitive investment environment where institutional asset managers are increasingly scrutinized for seemingly unoriginal products with excessively high fees and lackluster performance, product managers are looking for unique ways to differentiate themselves, re-craft existing products, and drive additional business. One way to accomplish this is to offer a 130/30 strategy. With this type of product, $100 million worth of equities is initially purchased for a portfolio. Meanwhile, $30 million worth of equities is borrowed from a market maker and sold or “shorted” and the proceeds added to the original $100 million portfolio, thus yielding a $130 million net long and $30 million net short or 130/30 portfolio. The strategy is designed to double up on the best long investments expected to appreciate in price with proceeds from short securities expected to fall in price.

Typically long-only investors would simply avoid purchasing stocks of companies which they found overvalued or fundamentally challenged. In other words, if your presentation to a group of long-only investors who did not own your stock was less- than-inspiring, then nothing would happen. These investors would exit the meeting and refrain from purchasing your stock. However, if you made the same presentation to a group of disappointed non-traditional or alternative investors who did not own your shares, these investors could leave the meeting, walk over to their trading floor, and short your stock, placing downward pressure on its price. Ouch!

With the increasing popularity of 130/30 strategies and the variety of accompanying flavors, including 120/20 through 150/50, traditional asset managers are now dabbling in the world of hedge funds, differentiating their products from peers while charging higher fees including the typical 1% active management fee supplemented with an often lucrative performance-based incentive. Within large investment shops and an increasingly larger number of smaller asset managers as well, hedge fund analysts are sitting side-by-side traditional long-only investors. For company executives now presenting before these mixed teams of investors, there may be much greater near-term risk to your stock price. Often hedge fund investors have shorter-term investment horizons, thus, creating excessive volatility, especially in thinly-traded smaller cap securities. Many times hedge fund analysts working for long-only shops are relatively inexperienced at shorting, having matured and developed largely within long-only environments. This inexperience adds to the overall risk level. Understanding your investment audience and its product offerings, including alternative investments, can better prepare you for presenting before this diverse group of investors.

Sharon Merrill
Chairman & CEO

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