M* and Rekenthaler vs Converted Hedge Funds
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Wednesday, April 26, 2017

M* and Rekenthaler vs Converted Hedge Funds

Morningstar is about to change the way it handles mutual funds that have converted from being hedge funds. Surprisingly for M*, the change involves a reduction in disclosures, not an increase.

In his column on Friday, M*'s John Rekenthaler reveals that "sometime soon ... Morningstar will remove all hedge fund histories from mutual funds." So for mutual funds that started out as hedge funds, much of their performance history will soon disappear from the offerings of the traditionally disclosure-friendly Chicago-based investment research giant. And Rekenthaler even wants the SEC to take M*'s lead and "muzzle" mutual funds that used to be hedge funds from publishing their pre-mutual fund track records.

"Showing extended track records is an investor drawback, not a benefit," Rekenthaler writes. "With some funds, on some occasions, the additional numbers will provide a fuller, more-accurate view of how the fund will perform in the future. But often they will accomplish the opposite. And there is no way that an investor can tell the difference between the two situations. They look identical from the outside."

(It's worth noting that M* already only looks at converted funds' mutual fund track records, not their past performance as hedge funds, when awarding star ratings and the like.)

Rekenthaler argues that "the performance figures for hedge funds that have converted into mutual funds are not helpful." He singles out the Catalyst Hedged Funds Strategy [profile] in particular. That fund, which now has $2.8 billion in AUM, suffered a 15-percent one-week fall earlier this year, and Rekenthaler worries that "nothing in the fund's 12-year history suggested that it could fall like that."

Yet the Catalyst fund did previously suffer a big drop, 18 percent over four weeks, back in 2006 when it was a new hedge fund, long before it converted into a mutual fund in 2013. Rekenthaler himself even pointed out that 2006 drop in a previous column two months ago, a point missing from his newer column. And commenters on the newer article pointed out that the Catalyst fund also suffered other big dips, including ones in February and April 2007.

M* has long been a champion of more industry disclosures in both its own publishing and in its advocacy with the SEC. Yet now Rekenthaler and M* are pushing the opposite direction, arguing that too much information about mutual funds' past lives as hedge funds is misleading investors, even though in this case the performance history from a mutual fund's past hedge fund life might've actually given some advisors and investors warning of painful drops — like when Catalyst Hedged Futures Strategy, now a mutual fund, fell 15 percent in a week in February 2017. Without seeing that old hedge fund performance history, to paraphrase Rekenthaler's initial point, nothing in the mutual fund's nearly four-year history suggested it could fall like that.

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