AQR hedging its bets with big mutual fund plan

NEW YORK (Reuters) - AQR Capital Management LLC, among the world’s largest hedge fund managers, will introduce another hedge fund-style mutual fund next month, as it expands its reach beyond the biggest investors.

Greenwich, Connecticut-based AQR, a $20 billion firm led by former Goldman Sachs Group Inc GS.N star Cliff Asness, led a new wave of hedge funds marketing to the masses when it launched the AQR Diversified Arbitrage Fund ADAIX.O in January.

“We, in about two weeks, expect to introduce a whole new series of style exposures for retail investors,” AQR co-founder David Kabiller told Reuters in a rare interview.

Long available only to the ultra rich, "alternative" investments are increasingly being sold to small investors with as little as $5,000 on hand. Highbridge Capital Management, a unit of JPMorgan Chase & Co JPM.N, led the way in 1995, while Legg Mason Inc's LM.N Permal Group hedge fund unit rolled out the Tactical Allocation Fund LPTAX.O in April.

John Rekenthaler, vice president of research and new product development at Morningstar, said about $100 billion was invested in hedge style mutual funds. He expects the number of such offerings to double over the next two years.

AQR is the most ambitious hedge fund firm in this regard. Kabiller said AQR plans over time to offer a series of funds it hopes are innovative and unique in the crowded field.

AQR wants to be regarded as the Vanguard of hedge funds, an advocate of lower cost, better managed portfolios in an industry where hedge funds are secretive, charge high fees and do not always deliver the returns they promise.

“We don’t want to be theoretical academics. We want to be the guys who demystify alternative (investments) and tell people what’s under the wizard’s hat,” Kabiller said.

Six decades ago, U.S. regulators divided the investment world into closely watched, long-only mutual funds and hedge funds, lightly regulated pools that can short stocks, use leverage and were exclusive to large or wealthy investors.

But those lines are getting more blurry by the day. In just the past week, Van Eck Global became the latest manager to unveil a hedge style fund, while Bull Path Hedge Fund converted itself into a mutual fund.

Into the fray jumps AQR, a firm that relishes going against the flow. Last month, when most hedge funds were cowed after President Obama criticized Chrysler creditors as “speculators,” Asness drafted a widely distributed letter that defended funds and took issue with Obama’s actions.

One plan in the works is “AQR University,” which will tap the firm’s more than 20 finance professors and PhD’s on staff to help make investors more comfortable with hedge fund strategies.

That said, Kabiller said hedge funds by design should never be allowed to get too big. With only 60 mergers pending at any one time, arbitrage strategies would suffer with too many assets.

“The stuff we’re doing on the alternative side, if we’re true to it, has real finite capacity,” he said.

Which is why AQR intends to offer a series of retail funds, including some strategies that can be expanded to several billion dollars.

AQR also wants to widen its reach beyond institutional investors, which have pulled back from hedge funds since last year’s market turmoil. Record redemptions slashed hedge fund industry assets nearly in half to $1.3 trillion and experts forecast the outflows will continue.

Kabiller said AQR manages $13 billion in traditional long- only funds, as well as $7 billion in various arbitrage strategies. Mutual funds could become a major new business.

“We’ve always been a big believer in diversification, both in our investment portfolios and in our business,” he said.

Convincing small investors to buy these funds will not be easy, though. Hedge funds are viewed as high risk and their reputation is in tatters after their worst performance in decades. Moreover, hedge funds by design should post modest gains when stock markets are booming.

To be sure, Mom and Pop investors will not get a piece of the high-octane, high-risk action sold to the rich. Hedge-style mutual funds will use less leverage and deliver tamer returns.

Kabiller acknowledged the firm has its work cut out convincing small investors that esoteric convertible arbitrage and merger arbitrage is less risky than owning the S&P 500 Index.

This year, the AQR mutual fund is up around 4.5 percent, half the gain in the S&P 500. But in mid-March, when U.S. stocks were down 20 percent, the fund was little changed.

“I’ve always believed the hedge fund industry is the ‘emperor who wore no clothes.’ There is some skill, some talent out there, but it’s not scalable,” he said. “We have a lot of educating to do, but when you have truth on your side -- this is valuable in your portfolio, here’s how it works -- it’s something we enjoy.”

Reporting by Joseph A. Giannone; editing by Andre Grenon