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    good article

    The fund conundrum

    As hedge funds try to catch up with the rally, some may get burned, but stocks should go higher.
    September 27, 2003: 9:26 AM EDT
    By Justin Lahart, CNN/Money Senior Writer

    NEW YORK (CNN/Money) - It has been a very good year for many mutual funds. It has been a very bad year for many hedge funds. The interplay between these two could create a powerful dynamic that could propel stocks higher through the end of the year.

    The rap on mutual fund managers is that they're so prone to herding (a point Gordon Gekko makes in the movie "Wall Street") that they never beat the S&P 500. But this year, that's not true at all. The S&P is up 14 percent so far and two-thirds of U.S. diversified funds are beating it, according to Morningstar.

    For the battered mutual fund industry, that's good news. But fund managers also have to worry, because the secret to their success lies in outperforming tech and biotech names. These are dangerous and volatile stocks -- "high beta" in the nomenclature of Wall Street -- with stretched-looking valuations. When they go up, they go up big, but when they go down, it hurts.

    So, many fund managers are probably considering selling these stocks and moving into lower-risk issues. In a recent research note titled "The Risk of Blowing Your Year" Morgan Stanley strategist Byron Wien suggested that investors consider lowering their tech and financial weightings and shifting into some of the lagging areas of the market.

    "I see the shift occurring, with a grudge," said Credit Suisse Asset Management managing director Stanley Nabi. "Many areas of the market have become undervalued. They could show decent returns in the next 12 months."

    Without, he added, all the risk inherent in the high beta names.

    Grab that tiger
    But in the hedge fund world, things are different. Through the end of August, equity-only funds that both short stocks and go long were up 8.6 percent on the year according the CSFB/Tremont Hedge Fund Index, compared with an S&P 500 gain of 14.6 percent. Some funds are doing far worse, having bet against the rally in stocks.

    "There are guys out there that have a lot of catching-up to do," said Brad Ruderman, managing partner at Beverly Hills, Calif.-based hedge fund Ruderman Capital Partners. "They're going to have to be bailed out by a drop in the market, or they're going to have to join the party."

    One that is generating a lot of chatter on Wall Street is $9 billion hedge fund Andor Capital Management, which The Wall Street Journal reported was down 11 percent at the mid-year point. Lately there have been rumors that it has begun to unwind its short position in technology stocks and is going long. Andor did not return calls for comment. Hedge funds are legally bound not to discuss performance publicly.

    Hedge funds that are doing poorly headed into the last quarter of the year are in desperate straits, explained Ruderman. Unlike underperforming mutual funds, hedge funds that fare badly are regularly forced to liquidate. The manager can start a new fund, if he still has the credibility he needs to raise capital. Or maybe he can just go back to work for Merrill Lynch.

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    As underperforming hedge funds try to catch up, drops in the market will be seen as an opportunity to get out of short positions somewhat painlessly, and to get into the stocks that outperform in a rally -- the risky issues mutual funds have started to dump.


 
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