One topic we have covered here at Abnormal Returns has been the rise in 'hybrid funds', that is mutual funds that utilize hedge fund-like tactics within the confines of a regulated open-end mutual fund.

Elizabeth Spiers at highlights an article that chronicles the rise in hedge fund investing for the masses. Not surprisingly Spiers is skeptical that either the investors or the managers of said funds know what they are doing.

Indeed the article referenced, by Dominic Basulto at, goes on to chronicle the fallout from the growth in the hedge fund industry. This includes the rapid growth in new investment opportunities for individual investors, like hybrid funds. Basulto characterizes this search for alpha as a fad,

However, sophisticated investment strategies for the average investor are as much a fad as the Internet was a fad.

We were somewhat taken aback by these comments. On one hand Spiers and Basulto are absolutely correct in their assessment of the hedge fund industry. In all likelihood there are too many managers, with too little experience and too much money under management, seeking out too few opportunities. Some have argued that hedge fund returns have been overstated thereby making them seem more attractive than they have been in reality. Both the managers and investors would be better served spending their time elsewhere.

The growth in hedge funds has been in a large sense a marketing bonanza for investment firms of all stripes to simply "give the people what they want." If they want hedge funds, by golly, let's give them hedge funds! This does not cancel out the potential benefits of hedge funds.

If you concede that there are some managers out there that do have skill, i.e. the ability to generate alpha, then as an investor one should want to give them the freedom and flexibility to best utilize those skills. For now the hedge fund, or in a more limiting case a hybrid fund, give the manager the best shot of generating alpha.

It could very well be the case that the hybrid fund movement loses steam and goes the way of other mutual fund fads. There is no doubt that many investors in these funds do not know what they are getting into. (One can easily argue that the majority of individual investors need to be better educated on all manner of finacial topics.)

The fact of the matter is most managers will fail, after taking into account all costs, to live up to the hype and generate alpha. However that does not mean we should not give the managers, and informed investors, the chance to use the most appropriate vehicle to achieve this elusive goal.

*Once again, bonus points for those who got our article title reference.

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