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In a Harsh Climate, Funds Get Creative

Unwanted adventurism or canny flexibility?

Gregg Wolper, 08/28/2012

To avoid potential legal issues, the typical mutual fund prospectus is remarkably broad (or, some would say, annoyingly vague). After slogging through pages and pages of technical details, an investor might conclude that the fund can do anything it wants. For example, conventional stock funds that intend to fill their portfolios entirely with common equities usually allow themselves the freedom to use derivatives, own bonds, or raise large amounts of cash, even if the managers have no intention of doing anything of the kind.

In practice, though, the strategies of most funds are fairly well circumscribed. Most managers would prefer to focus on their areas of expertise, and most advisors and shareholders became less accepting of true go-anywhere mandates over the years. Since the financial crisis that began in 2007, though, it has become more common for managers to use the freedoms their prospectuses provide. Morningstar's director of fixed-income fund research, Eric Jacobson, noted this pattern among bond funds last year.

To a lesser extent, stock funds are taking advantage of this leeway as well. In July, senior analyst Laura Lallos outlined how some equity-fund managers are investing in other funds, both public and private, to gain exposure in areas outside their usual purview.

It's even easier to find managers who have become less absolutist in informal ways--for example, by searching for a few opportunities in sectors or regions that they generally consider unattractive, instead of simply writing off the whole lot. Hard data is tough to come by, because some of these actions don't have to be reported in ways that can be easily tracked. But the trends seem evident.

Some investors may consider such activity to be unwanted adventurism, while others might welcome it an open-minded approach that's in their own best interests. In any case, it would be wrong to make a blanket evaluation of the merits. Often, determining whether stretching the investment boundaries is a wise idea comes down to the specific move in question, and of course, to the success of the execution.

Outside the Norm 
Former Janus manager Laurent Saltiel moved to AllianceBernstein in 2010 and now heads up the international-growth team there. His young fund, AllianceBernstein International Focus 40 AIIAX, runs with a compact stock portfolio targeting foreign markets. It's not billed as a long/short fund. However, the prospectus allows Saltiel to sell stocks short (that is, bet that their prices will fall), and unlike the vast majority of his peers, he does so. He says he had experience shorting stocks in a Janus fund not available to retail investors, and during a prior stint at a hedge fund.

Saltiel also hedges some of the fund's currency exposure, a tactic that used to be uncommon for international funds. Until a few years ago, nearly all foreign-stock funds were fully exposed to foreign currencies in their portfolios. Their shareholders preferred it that way, and the fund companies figured their managers were better off focusing on company analysis rather than trying to forecast currency movements. But while fully hedged stock portfolios remain rare, partially hedged ones now show up far more often than they used to.

It was surprising, for example, that Harbor International HAINX initiated a currency hedge against the Swiss franc in 2011. According to the managers, they hadn't used currency hedging in almost 20 years but felt it appropriate at a time when the Swiss franc was soaring to historically high levels as worried global investors sought refuge from the euro and the U.S. dollar. At about the same time, Dodge & Cox International DODFX also initiated a hedge on the Swiss franc, only their second foray into currency moves.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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