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Thursday October 06 2022
Fund-of-Funds Popularizes Investment of Super Rich: Friedland's Magnum Fund Diversifies and Caters to Clients' Risk-Reward Needs

Forward  March 13, 1998



       Dion Friedland was sleeping in a Sydney hotel in the wee hours of that long-ago day in October 1987 when his broker called with the bad news: The Standard & Poor index was down 300 points. Mr. Friedland, a global investor, thought he was having a bad dream and hung up. When his broker called back a half-hour later the index was down 500 points. Staring at the sailboats in the Sydney harbor, Mr. Friedland learned that he had lost half his net worth.

      In the aftermath of the 1987 crash, Mr. Friedland pulled his money out of the stock market and moved into hedge funds. It was a calculated risk that has paid off handsomely: From 1988 to 1993, Mr. Friedland's hedge fund investments grew by 47% annually, and in April 1994 he launched the Miami-based Magnum U.S. Investments Inc. A "fund-of-funds," Magnum offers the investor a wide array of funds, including the Magnum Opportunity Fund and the Magnum Russia Fund, which was up 74% last year. At present, Magnum operates 20 offshore funds and two domestic funds, and sponsors 15 single-manager funds.


      Mr. Friedland's meteoric post-crash rise suggests that hedge funds, long regarded as the wild card of investment vehicles, remain largely misunderstood in the finance community. Contrary to conservative claims that hedge fund managers do not appreciate the relationship between risk and reward, Mr. Friedland argues that managers retain greater control of their investments because hedge fund performance does not correspond directly to market performance. More importantly, he maintains that funds-of-funds are revolutionizing the hedge fund market and, in fact, making hedge funds safer investments than mutual funds. "It's like putting a cork on the ocean," Mr. Friedland says. "With a mutual fund, they have no control over the performance. Hedge fund managers try to turn their cork into a submarine, so they keep going in a straight line, through the water."


      Simply put, funds-of-funds take investors' money and invest that money in a number of different hedge funds -- at Magnum, the average fund-of-funds invests in 10 to 20 funds, thereby eliminating the most serious drawback of hedge fund investment: overinvestment in a single fund. This overinvestment is a function of high barriers to entry. Minimum entry denominations are generally $1 million. Most fund-of-funds require an initial investment of $250,000.


      A managing director of SITE Capital Management in Scarsdale, N.Y., Andy Serotta agrees that the advantage of a fund-of-funds such as Magnum is its capacity to make portfolio diversification easier and more affordable. Says Mr. Serotta, "The fund-of-funds takes not-so-little investors and pools their money." In this way, diversification "democratizes" the market by expanding the hedge fund fran-chise. Although the fund-of-funds is not for the typical mutual fund investor, Mr. Serotta says, it has opened up the hedge fund arena to a number of investors who would not have considered that market otherwise.


      Mr. Serotta believes that pooling money, what some analysts refer to as the "mutual fundization" of the hedge fund market, also represents an important evolution in the financial community. Once reserved for an elite cadre of investors, investments in hedge funds have become a mainstream financial product. "There isn't all that much new in the financial world. There are just variations on old themes," he says. "People have always wanted to diversify investments. The fact that there's a fund-of-funds is no more than someone taking advantage of that desire."


      "Getting it right," Mr. Serotta estimates, is the real name of the fund-of-funds game. As the number of hedge funds explode, funds-of-funds will provide investors with the information to invest in those funds. "At the absurd level," he says, "funds-of-funds could give their money to other funds-of-funds. It's an information game, matching investors with investments."


      Mr. Friedland agrees that providing information is one of the central missions of any fund-of-funds. He says that there is a panoply of hedge funds available. Hedge funds range in terms of size, volatility and investment scope: from high-risk global macro funds that revolve around policy shifts (such as interest-rate hikes), to convertible bond arbitrage, which poses fewer risks than the average mutual fund because its performance is unconnected to the stock market.


      "If you go to the zoo, you'll find crocodiles and zebras and bears -- they're all different," Mr. Friedland says. "The reality is that hedge funds vary enormously in terms of risk and reward." This variety, Mr. Friedland says, appeals to investors who have different risk-reward needs. That investors, via fund-of-funds, are able to channel their money into specialized funds indicates how much the industry has developed in recent years.


      David Friedland, Mr. Friedland's son and the director of Magnum, agrees that the hedge fund market has matured. "There will be new funds," says Mr. Friedland. "Fees will come down. It will expand the asset base of the hedge fund industry." At the same time, Friedland expects a number of funds to stop accepting new money. He points out that one of his own funds, the Galleon Omni Fund, after only a year-and-a-half of stellar growth, is no longer accepting new money.


      Many in the investment community are not confident, however, that the success of funds-of-funds will continue. They point to the stock market's unprecedented growth over the course of the past 15 years and note that it is difficult to discern between the shrewd investor who understands hedge funds and the Young Turk who has fared well in fair weather times.


      One former hedge fund manager said it was misleading to suggest that hedge funds were unaffected by stock market performance. While hedge fund managers often claim they can deliver high returns irrespective of market volatility -- that is, steer their submarines through rough waters -- it is difficult to speak in general terms. "There are so many different strategies out there, it's really hard to make any blanket statement."


      Friedland père demurs: "Our funds are some of the best performing in the world." Reminiscing about his early fund-of-funds days, he recalls, "My friends used to send me their money. 'Please invest it for me,' they'd say. 'Please.'"

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