There is an interesting post at the A VC blog on a new type of investment approach, called Covestor Investment Management (CV.IM). [Hat tip to all the Twitter tweets that pointed to the link]. The post describes the CV.IM as:

"The world’s first retail Multi Managed account or MMA. With an MMA you can invest directly alongside professional and retail investors, managing their own money in their own account. It is a new category of Investment product that gives you access to expert managers like a hedge fund with the security and transparency of a managed account."

Basically, the system is designed such that you would have your own account, but could then choose from a number of investment managers that you want to follow. The investment managers could be in the financial industry, or more likely just an average investor like you, but possibly with more experience, and with a track record or strategy to your liking. If you choose to follow the investment manager, funds in your account are used to mimic the trades of the manager. In return, the investment manager could get some compensation for sharing his/her data, although they can also continue to share their investment ideas for free.

It seems that such a structure could have some advantages. First, the fee structure is certainly less than a mutual fund or hedge fund for following the free managers, and also much less for even those charging a following fee (listed as $120 per person per manager). The system could also end up offering a number of investment options and strategy choices for free. For aspiring investment managers, there is also the opportunity to "prove yourself" and your strategy, and make a little money in the process.

Nonetheless, there are a number of questions. While the company does have a system in place to report performance, it is not clear how much data is available, or how accurate it will be if trading data/history is introduced for new managers. It is also unclear whether or not the managers could somehow game the system, or receive an unfair advantage by front-running the followers. One of the founders did respond in the post comments section that there will be minimum liquidity restrictions to prevent some abuse, but the managers could still have an initial advantage over new followers. The minimum daily trading volumes of 10,000 shares and $50 million in market cap also seem a little low. It is also worth noting that the managers will most likely be timing their buying and selling based on what is most beneficial to them, and not necessarily your current situation, causing you to possibly incur a commission and/or tax event at an inopportune time. Such a structure could also lose the ability to take advantage of scale with regard to transactions, unless a large number of investors are already following a particular manager (scale advantages are still possible given that most of the funds will be with only a few brokers - so far TD Ameritrade and Interactive Brokers). Nonetheless, new followers would most likely have to pay higher per share fees.

Although there are still numerous questions to be answered, the idea sounds intriguing, and is certainly worth pursuing more. Check out the Covestor website to learn more.

Hedge fund firm AQR Capital Management has launched a set of indexes designed to capture the returns of stocks that have positive momentum (see WSJ article). In addition, the firm launched three no-load mutual funds that will track the new momentum indexes. The AQR Momentum Fund, AQR Small Cap Momentum Fund, and AQR International Momentum Fund will track the AQR Momentum, Small Cap Momentum, and International Momentum indexes, respectively.

The new AQR indexes are constructed using the top one-third of stocks that have outperformed other stocks in their grouping over the last 12 months, with the stock weightings based on market capitalization. The large-cap index examines the 1,000 largest U.S. market cap stocks, while the small-cap index will examine the next largest 2,000. The indexes are rebalanced quarterly. The designers of the funds hope that investors will use them to represent the growth portion of their portfolio since momentum-based portfolios tend to do well when value strategies are not in favor. Pure growth strategies also tend to under-perform momentum strategies over time according to a principal at AQR. Nonetheless, each momentum strategy needs to be somewhat specific, making it difficult to do a direct momentum for growth substitution, but could still prove useful for those looking for diversification with their momentum investing.

Actively managed mutual funds have done well this year, rising 9.9% through June 10, compared to the S&P 500, which was only up 5.3% over the same period (see WSJ article). This comes after a year in which the average stock fund was down 38.9%, dropping 1.9% more than the S&P 500. What is causing the out-performance? It appears to be growth stocks, which are up approximately 11% this year, compared to less than 1%gain for value stocks. Many widely-held tech stocks, such as Apple (AAPL), Cisco Systems (CSCO), Google (GOOG), Hewlett-Packard (HPQ), and Microsoft (MSFT) have helped juice returns. Nonetheless, even with the current out-performance, active funds are still losing business to index funds as investors continue to remember their poor fund performance in 2008 (really poor in some instances).

According to a Financial Research Corporation report, equity funds and ETFs posted April net inflows of $8.5 billion and $6.9 billion, respectively, reversing the trend of outflows in March (see Investment News article). Corporate-bond funds had the largest net inflow in April at $16.6 billion, while international fixed-income funds had the largest net outflows at $447 million. As posted earlier, risk taking is back - at least it was in April.

The Grail American Beacon Large Cap ETF is now being offered to the public. While this would normally not be a big deal, this ETF is unique in that it is being billed as the first actively managed ETF (see WSJ article). There have been other active ETFs that diverged from a specific index, but the stocks choices for the fund were generated by computer models, as opposed to having a manager pick the stocks. In the tradition of lower fees for ETF, fees will be 0.79%, lower than a mutual fund, but still higher than a typical straight index fund ETF. Like other ETFs, the funds holdings will be made public daily, similar to mutual funds. Whether the ETF will be successful will depend on whether the company can avoid front-running of large public positions, and whether or not investors, who are already skittish and getting conservative, will be willing to invest with a product and a manager with an unknown track record. If history is any indication, the outlook is not good, especially given the timing.

A new study by Mark Kritzman, president and CEO of Windham Capital Management, found that standard index funds - those with their lower fees and expenses (including transaction costs, taxes, management fees, and performance fees) - gave better returns than actively managed mutual funds and hedge funds (see New York Times article).

For his study, which is similar to past studies, Kritzman calculated the average return over a 20-year period, net of all expenses, of three types of investment, including a stock index fund with an annual return of 10 percent, an actively managed mutual fund with an annual return of 13.5 percent, and a hedge fund with an annual return of 19 percent. He used volatility, turnover rates, transaction fees, management fees, and performance fees that were based on industry averages.

His finding pointed to the problem with high expenses. The actively managed mutual fund and hedge fund each had total expenses of more than 3.5 and 9 percentage points a year, respectively. As a result, in order to break even with the index fund net of all expenses, the actively managed fund would have needed to outperform the index fund by 4.3 percentage points a year before expenses. For the hedge funds, it was even worse, with each fund needing to outperform index funds by 10 points a year. While similar studies have been done in the past, the current finding are just yet another reason that the 2-20 hedge fund model may see more resistance going forward. Managers will no doubt be asked more than ever to verify their ability to capture alpha.

Many fund companies are expected to take a hit over the next quarter as a result of investors pulling money out of funds and parking their cash in money markets or Treasuries (see WSJ article). Mutual fund generate a large share of their revenue from fee income that is based on a percentage of assets under management. The market decline over the last month alone (recovered some yesterday) has reduced stock mutual fund AUM by $2 trillion, reducing a large chuck of fee generating capital. To add insult to injury, firms that generate a large portion of income from overseas are seeing even lower fees as the dollar strengthens.

Yet, everything may not be bad for mutual funds, hedge funds, and other forms of active management. As the market has declined, ETFs, which are often indexed to the S&P 500, DJIA, Nasdaq Composite Index, Russell 2000, or other subset of the market have seen their performance fall with the market, in many cases more than other funds under active management. While indexers will certainly point to the benefits of buying and holding for the long-term, individual investors looking at their financial statements and comparing returns to the ubiquitous lists of "star" mutual fund and hedge fund performance will no doubt begin to wonder whether it is worth giving up some return in order to have a professional actually manage the portfolio. Just as mutual funds were forced in some cases to lower fees in the 1990s as the market rallied and everyone felt they were a market genius (and index-based ETFs posted stellar gains by just riding along), the recent market downturn may have a reverse effect as investors realize they don't really understand the market or know what they are doing and need to pay-up to get professional management and stock selection. Ironically, the same funds that are being questioned for charging outrageous fees may be the same ones investors turn to for guidance and management.