Vanguard Group Flirts With Hedge Funds

The Vanguard Group, champion of the low-fee, index-driven money management model, is the last firm you would expect to dip its cautious toe into hedge funds. But it has done so — and the $1 trillion Valley Forge, Pennsylvania, asset manager seems intrigued by the possibilities.

In late January, Vanguard applied to the SEC for permission to invest its U.S.-based Vanguard Managed Payout funds in a fund it established in Ireland last August that walks and talks a lot like a hedge fund. Called the Vanguard Alternative Strategies Fund and authorized by the Irish Financial Services Regulatory Authority, that fund invests in a variety of active, absolute-return strategies. In its SEC application, Vanguard states that the fund “may employ leverage, derivatives, short sales and other complex investment techniques or transactions.” Hedge funds, with their high risks and even higher fees, would seem to be the very antithesis of everything Vanguard stands for: passive, not active, investing, with as little risk as possible and modest fees. But beyond saying that it prizes the diversification benefits of alternatives, Vanguard is mum about its motives.

Some industry insiders, however, say there’s good reason for the mutual fund stalwart to be contemplating a hedge fund option. Postcrisis, mutual fund investors want investments that promise returns uncorrelated to the stock market.

Ricardo Cortez, president of global distribution for New York hedge fund Broadmark Asset Management, sees huge pent-up demand among investors for mutual funds geared to alternative investments. Last November, Broadmark brought in Cortez, who had been working for fund-of-hedge-funds manager Torrey Funds, to build up its distribution.

Still, by flirting with hedge funds, is Vanguard betraying its roots? Perhaps not. A race is under way to design a mutual fund tied to a true hedge fund index. Pioneer IndexIQ, a Rye Brook, New York, firm that developed a hedge fund indexing approach, uses exchange-traded funds. Says CEO Adam Pattie, “We want to be the Vanguard of hedge fund indexing.” But it just may be that Vanguard wants to be the Vanguard of hedge fund indexing.