After determining an initial mix, we may decide that there's too much on the standard deviation side, so we need to dial down some of the managers to get in the right range. We might sometimes find that the risk stats are tame, but the return might be under our target. Then we can increase the aggressiveness of the mix, or add modest leverage.

Q:  What are the key risk control measures?

A: I think that transparency is a key risk control. It keeps the managers honest and executing the right strategy, so that we get what we expect in terms of risk-adjusted performance. On an ongoing basis, we analyze four key metrics –return, correlation coefficient to the S&P, annualized standard deviation, and beta. We make sure that those metrics stay within the range that we’re comfortable with. That range is targeted by manager, but our real job is to synthesize an overall composite fund that, in the end, provides good risk-adjusted returns to shareholders.

There are two other key controls embedded in a mutual fund structure that you typically don’t find in a hedge fund – independent valuation and independent custody. Independent valuation is a counterbalance and check to ensure the fund is properly valued and that managers are candid about performance. Regarding custody, when all the securities are resident in the name of our fund at an independent mutual fund custodian bank, you avoid hedge fund fraud cases, where a manager may abscond with assets of the fund. In our case, our sub-advisors can only execute trades that settle against the separate account they're managing; they cannot pull out cash or securities.

So the three key protections, transparency, valuation, and custody, take out a lot of the risk that potentially resides in the hedge fund vehicle. The incidences of problems in the hedge fund world are few, even though they are widely publicized, but nevertheless, these measures make it easier for retail investors to benefit from the attractiveness of hedged strategies.

Q:  What type of strategies do you generally like?

A: Currently, we have the basic arbitrage styles; convertible bond arbitrage, fixed-income arbitrage, merger arbitrage. We also have a number of long-short equity strategies, not just domestic, but also international and global long-short managers. We have a longshort REIT manager, and a deep discount value long-short manager that deals with micro to small-cap names, where there are more market inefficiencies. We have three approved managers for distressed securities, a very attractive risk-adjusted return market segment.

Typically, hedged strategies find such inefficiencies in smaller pockets of opportunity, which is why we have a bias towards managers with assets of $50 to $200 million in a given strategy. If somebody’s managing $2 billion in a strategy, it’s very difficult to find opportunities where they can deploy all that capital, so their returns may diminish over time, or they have to reach for more directional exposure to get the return.

Our Alpha Fund, which is a market neutral product, tends to be used primarily as a fixed-income substitute. Our more aggressive Beta Hedged Strategies Fund (BETAX) will be used as a substitute for being long the equity market.

Q:  How often do you change the weightings of the various strategies?

A: It’s a very actively managed portfolio and I'm not doing this alone. An affiliate, our portfolio research consultant, has been very active in the hedge fund of funds business for many years, so we collaboratively adjust the weightings. As we evolve and add managers, we make sure that we’ve got room to add new strategies. We don’t want to be moving the percentages and the strategies up and down too frequently, so we try to plan it out in stages.

We’ve been fairly active at times. In certain strategies you see conditions changing to being favorable or not-sofavorable. In 2004, and the beginning of 2005, we let convertible bond arbitrage diminish from 20% to 12%, because it was clear that there was a real imbalance in the supply and demand for convertible situations. Then, in May 2005 our manager was seeing a real opportunity going forward in the spreads. He felt that a lot of the dislocation was over, so we decided to increase our allocation back up, and the result was quite positive.

Q:  Is there an investment minimum for the fund? I guess it would be lower than the minimum for a hedge fund.

A: Oh yes, much lower. The investment minimum is $10,000 if you invest directly with the Fund, but most of our clients are advisors that use Schwab, Fidelity, or TD Waterhouse, who are able to set lower minimums. I think that with Schwab and Fidelity it is $2,500, while with TD Waterhouse it might be as low as $1,000.

So, investors get access to the type of strategy that historically required half a million to get into. In addition, it provides features, such as not being locked up for a year, which provides the type of comfort investors have with mutual funds, as long as the strategies are the right ones. Once we launch our second fund, we’re going to look at adding some load share classes for the brokerage channel by the end of June.