The dollar has experienced its sharpest rise in five decades. That, coupled with robust European and ongoing Japanese quantitative easing, has made investors increasingly wary. Understanding how the dollar achieved these remarkable gains is important in understanding the potential consequences.

A Perfect Storm

In response to the 2008 financial crisis, the Federal Reserve flooded banks and capital markets with liquidity. Contrary to conventional wisdom, the dollar strengthened, largely because global investors viewed the United States as the “best of the worst” in terms of risk. Global investors began exchanging their foreign currency for dollars to buy U.S. Treasuries, thus strengthening the dollar.

At the same time, foreign governments, anxious to rescue their economies by making exports more affordable, began to systematically reduce the value of their own currency by exchanging them for dollars. The collective demand for the dollar by investors and governments has steadily increased the strength of the dollar on the global stage.

Impact on the U.S. Economy

In a global economy where the U.S. dollar is the elephant in the room, the U.S. economy is gaining ground while most nations are struggling to achieve GDP growth. As you would expect, the strong dollar and growing economy will attract capital. Additionally, the Federal Reserve is about the only central bank hinting at raising rates. When that happens, the dollar will strengthen further.

As a consequence, U.S. exports are becoming more expensive. This is of particular concern to large multinational corporations earning as much as 40% of their revenues overseas. When foreign revenues are converted to dollars, corporate bottom-lines take a hit. For example, Pfizer Inc. anticipates a nearly $3 billion revenue hit as a direct result of currency impacts in 2015.

How Hedge Funds Are Responding

Hedge fund managers largely agree that the dollar will continue its rise. The Euro continues to experience downward pressure as the ECB lowers interest rates and the specter of the Greek exit still looms large.

Hedge fund managers perceive the rising dollar as a disincentive to any rate hike by the Federal Reserve; as such action would further strengthen the dollar and depress U.S. GDP growth. As a result, hedge funds pursuing a long/short equity strategy are relatively comfortable with their chosen tactic.

Forex hedge funds, particularly those focused on the USD/ Euro pair, are well-positioned to benefit from the strengthening dollar as are funds employing an emerging market strategy.

Even high risk global macro funds are exploiting opportunities in the strong dollar trend, anticipating a rise in European stock prices as a result of the ECB’s quantitative easing policy.

In short, hedge fund managers are seizing the opportunities offered by the strengthening dollar and the stage may be set for significant gains in the industry as 2015 unfolds. However, the continued uncertainty surrounding the question of when the Federal Reserve will implement a rate increase remains the principal driver of market volatility and will ultimately determine the future strength of the dollar relative to Euro and other major currencies.

 

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The year 2014 witnessed the average alternative mutual fund outperform the average single manager hedge fund by 58 basis points. Single manager hedge funds returned an average of 3.78 percent, while alternative mutual fund returned an average 4.36 percent during the same period. At the same time, the S&P 500 sported 11 percent gains. What’s an investor to do!

Alternative mutual funds tout five distinct advantages for would-be investors, liquidity, robust regulation, superior returns, reduced fees and limited barriers to participation. But are alternative mutual funds the “blue-light special” of investment strategies?

Liquidity

Both open and close-ended funds are extremely liquid compared to hedge funds. Those investing in open-ended funds can redeem on any trading day and receive the current market value in 5 days or less. Close-ended investors can redeem only at maturity but can sell units in the secondary market like stock. In short, alternative mutual funds’ claims of liquidity are valid.

Regulation

Mutual funds, including alternative mutual funds are subject to a greater degree of regulation and oversight than are hedge funds. Mutual funds, unlike hedge funds, are required to register with the SEC. Additionally; the Investment Company Act of 1940 requires that mutual funds have a board of directors, 40 percent of whom must be independent, charged with the responsibility of looking after the shareholders interests.

Returns

The average performance of alternative mutual funds exceeded the average performance of single manager hedge funds in 2014 by 58 basis points. However, this is not indicative of a trend the relatively short track record of alternative mutual funds.

Fees

At first blush, fees for alternative mutual funds appear lower than hedge fund management fees. However, alternative mutual funds are notorious for a variety of other fees, including “loads” and expense fees. The totality of these fees can meet or exceed average hedge fund management fees. For example, mutual fund expense fees average 74 basis points, but the average expense fees for alternative mutual funds stand at 134 basis points.

Barriers

Unlike hedge funds, limited to a clientele consisting of qualified investors, alternative mutual funds are open to anyone having the price of admission, which is typically $1000 to $5000. Hedge funds seek investors with $1 million or more to invest and these investors need to prove they can afford to lose it.

Pretenders to the Throne

Alternative mutual funds lack appeal for institutional and other major investors for the following reasons.

  • Liquidity is not a major concern for institutional investors who have fractional amounts of their total assets under management invested in hedge funds.
  • Institutional investors view highly regulated investment vehicles as impediments to successful strategies.
  • Returns, while important, must be viewed through the lens of risk mitigation.
  • Fees are always negotiable and institutional investors have enjoyed significant successes in securing fee reductions.
  • Lastly, entry barriers are not a concern for institutional investors.

For these reasons, alternative mutual funds will remain pretenders to the throne occupied by hedge funds.

 

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