CHAPEL HILL, N.C. - Do mutual fund investors crave investment performance more than they fear derivatives?
Executives at Smith Breeden Associates Inc. think some do, and are going after them with an enhanced index mutual fund focused on outperforming the Standard & Poor's 500 Stock Index by 100 basis points annually.
The fund, called the Smith Breeden Market Tracking Fund, uses a strategy already used at institutions: transferring alpha (returns relative to a benchmark) from one asset class to another. Smith Breeden's portfolio managers take alpha from investments in mortgage-backed securities and combine it with returns of the S&P 500.
Smith Breeden captures the S&P 500 returns through futures contracts and swaps; leverage in those instruments frees up cash to be invested in mortgage-backed securities. Interest rate risk in the mortgage-backeds is fully hedged, also using futures contracts or swaps. For as long as Smith Breeden's mortgage-backed positions outperform its hedge positions net of transaction costs, the fund should outperform the S&P 500.
Michael J. Giarla, president of Smith Breeden Family of Funds, said that despite losses and negative publicity associated with derivatives, "it's the returns that get people's attention." People need to understand that derivatives are used for risk management, he said. Investors that got into trouble using them either claimed they weren't taking risks that they were, or didn't know what they were doing, Mr. Giarla said.
He said Smith Breeden tries to outperform by seeking inefficiencies in the mortgage-backed market, which contains a lot of "unsophisticated" investors. While the Smith Breeden fund only has about $3 million in assets, Mr. Giarla said, it is getting a marketing push from Smith Breeden because of its three-year track record.
According to data from Morningstar Inc., Chicago, the fund had annualized returns of 15.1% for the three years ended June 30, compared with returns of 13.3% for the S&P 500. Morningstar just assigned it a four-star rating.
The fund appears to be doing a good job of tracking the S&P 500. About 97% of the fund's returns can be explained by the S&P 500 (as measured by its r-squared), according to returns-based style analysis data provided by Zephyr Associates, Zephyr Cove, Nev. Its standard deviation, at 8.49, is slightly higher than the S&P 500's 8.26, according to Zephyr.
AUSTIN, Texas - The $6 billion University of Texas System endowment fund expects to search this fall for counterparties for an international equity swap strategy, said Brian Borowski, endowment officer.
He said the fund probably would seek several counterparties to diversify counterparty risk, possibly using a different counterparty for each international index. He said the fund hasn't decided how much it will invest, but suggested it could be around $100 million.
The strategy is designed to give the fund international equity exposure without the custody, settlement, dividend tax and other costs typically paid by investors in international stocks.
Under the swaps, which would have a five-year maturity, the fund would pay a LIBOR return to the counterparties, which in exchange would pay the fund the return on major international stock indexes.