The Benefits of Hybrid Mutual Funds

Abstract

Historically, mutual funds and hedge funds have differed not only as to the risk and return opportunities that they have offered but also in regard to their investment structure. In recent years, regulatory changes have increased the ability of mutual funds to offer investment strategies that are “hedge fund-like” and include short-selling as well as the introduction of the limited use of leverage. In brief, today there exist an increasing number of mutual funds that offer investment strategies not provided by long only focused stock or bond mutual funds. Since the investment vehicles that these mutual funds employ are not pure traditional mutual funds and yet are restricted from being pure hedge fund in form, they have been classified by some mutual fund data firms (e.g., Morningstar) as hybrid mutual funds. These funds in many cases offer risk and return opportunities closer to that provided by some well-known hedge fund strategies. In this article the performance of various hybrid mutual funds is reported relative to traditional mutual funds as well as their relative performance compared to paired hedge fund investment strategies. The results of the author's analyses show that hybrid mutual funds provide affordable hedge fund-like mutual funds to small investors. In addition, as part of a larger portfolio, hybrid mutual funds can offer efficient diversification. They give investors exposure to benefits of derivatives instruments which most traditional mutual funds fail to offer.