A recent W$J article reports that a number of mutual funds have amended their fund investment policies to allow the funds to engage in hedge-fund-like investment strategies such as the use of derivatives, leverage and short-selling. I think this is a favorable development because it increases the types of investment options available to everyday investors. Others may not see it this way:Â
[S]ome analysts and financial advisers caution that when traditional mutual funds adopt alternative investment strategies, it could bring added risk and higher fees. Some advisers also fear that mutual funds may be rushing into a hot strategy just as hedge funds’ performance is beginning to cool.
The “added risk� and “higher fees� criticism seems little more than a statement of the obvious. Alternative investments, by their nature, are more risky and involve higher fees. What really matters though is whether a fund’s net risk-adjusted return beats the applicable benchmark.
It should be noted that even with appropriate changes to mutual fund investment policies, mutual funds cannot engage in various strategies to the same extent hedge funds can. This is because mutual funds are subject to regulations under the 1934 Act and the Investment Company Act (ICA) (among others); hedge funds are not. These regulations include, for example, limitations on margin borrowing and investing in restricted securities. Interestingly, the ICA empowers the SEC to adopt limitations on short-selling and margin borrowing specifically for investment companies, but to date it has not. Look for the SEC to do so if any of these hedge-fund-like mutual funds implode.