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Registered Hedge Funds Gain in Popularity

A total of 33 new hedge funds have been registered with the Securities and Exchange Commission over the past 12 months. Eight new hedge funds have been registered so far this year, including new offerings from J.P. Morgan and Merrill Lynch, both of New York.

While some advisors have yet to formally launch their registered hedge fund, others are getting comfortable with the unique product they have brought to market. Overall, both large and well-known advisors, as well as small and relatively unknown sponsors, are intent on offering an appealing investment strategy, formulating a sound plan for distribution, and finding a comfortable niche they can occupy in an increasingly crowded marketplace.

Man Investments, located in Chicago, the U.S. investment unit of London-based alternative investment giant Man Group, entered the U.S. registered hedge fund industry in 2002. Leveraging the expertise of its U.S. asset management subsidiary, Glenwood Capital Investments, it began by offering the multiple-manager, multiple-strategy Man-Glenwood Lexington, a fund-of-hedge funds.

Its newest initiative is the Man-Glenwood Lexington TEI (tax-exempt investors) fund, which was developed solely for tax-exempt and tax-deferred investors such as endowments, foundations and individual retirement accounts. The new hedge fund came to market on April 1.

The innovative product was designed to eliminate unrelated business taxable income (commonly known as UBTI). Under current U.S. tax law, even tax-exempt organizations are liable for taxes on the income earned from leverage used in some hedge fund strategies.

"When a tax-exempt organization buys into a look-through product, such as a hedge fund, the earnings flow through to the tax-exempt organization which then pays taxes on this," explained Michael Tannenbaum, partner with the law firm of Tannenbaum Halpern Syracuse & Hirschtritt in New York. But, he continued, this UBTI does not flow out of offshore corporations.

The new Man hedge fund eliminates UBTI by investing in a Cayman Islands company that has a U.S. custodian and a U.S. bank account. That Cayman Islands company in turn invests substantially all of its assets in a master fund registered under the 40 Act, explained John Kelly, president of Man Investments. "Tax-exempt investors eliminate UBTI by investing through an offshore vehicle," he said.

Because hedge funds are taxed as partnerships, investors must pay the applicable taxes each year on their proportional share of the net income and gains on the fund, even if no distributions are actually received by the partner/investor, said Dave Anderson, managing director of GAM Services of New York, sponsor of the GAM Avalon funds, a family of registered hedge funds. "These are not terribly tax-efficient vehicles," he said. "But offshore vehicles do not pass through the UBTI."

Multi-Strategy or Single Discipline?

The predominance of hedge funds that have been registered with the SEC over the past few years generally fall into two categories: those that provide broad diversification across several alternative investment strategies through a single fund, and those that stick to a single discipline.

Broadly diversified hedge funds tend to have multiple managers employing multiple strategies. The fund advisor typically doles out allocations of assets to each chosen sub-manager, often a hedge fund manager, as it sees fit.

Single-minded hedge funds are more narrowly focused and invest within one segment of the alternative investment spectrum, such as merger arbitrage or managed futures. In some cases, advisors will offer multiple hedge funds, each catering to a different investment strategy. Advisers to broad-based registered hedge funds hope to use that flexibility to maximize returns.

The multi-asset, multi-managed Robeco-Sage Triton Fund, which was registered with the SEC this past December, seeks to take advantage of broad market opportunities. According to the fund's initial offering documents, the nimble fund can participate in any market, strategy or investment. The fund is managed by Robeco-Sage Capital Management of White Plains, N.Y., a wholly owned subsidiary of Robeco USA, which in turn is the U.S. subsidiary of the Robeco Group of Rotterdam, the Netherlands. A Robeco-Sage Capital Management executive declined a request for comment.

Of course, the multi-strategy approach does not suit everyone. That's why Aspen Partners, an investment advisor in Atlanta, last August registered to offer four hedge funds with different core investment disciplines, although it does embrace the multi-manager approach. The funds, all of which debuted this past February, are managed by Aspen Strategic Alliance, a wholly owned subsidiary. Offerings include the ASA Debt Arbitrage Fund, ASA Hedge Equity Fund, ASA Managed Futures Fund and the ASA Market Neutral Equity Fund. Guidance Capital, a registered investment advisory firm in Chicago, serves as sub-advisor to the funds and determines which hedge fund managers to hire within each of the disciplines.