The Far-off Investment in Mutual Funds

First off, this is not the kind of thing you want to sink all of your investment dollars in. That might sound like a disclaimer, but the very idea that you could own a mutual fund that acted conversely to the way you want to react, a mutual fund that sold when markets were high and feasted when the markets were in trouble, and did so in many instances without so much as your normal hands-on knowledge, seems radical. You're an investor and you act like one.

Or you're an investor who knows that you aren't rational. And that is most of us. But a new study as uncovered that if you own a mutual fund far from where you live, you will allow it to do what it should do when the time is right. In other words, the farther away from your investment, as Miguel Ferreira of the Universidade Nova de Lisboa in Portugal, Massimo Massa of INSEAD in France and Pedro Matos of the University of Southern California found out, the more you agree with the hedge fund-like attitude the fund exhibits.

Hedge funds have long since known that you need a presence in the place you invest. It wasn't until a paper by Melvyn Teo of the Singapore Management University uncovered the fact that a geographic presence is key to investment success. This sort of "boots-on-the-ground" approach does make sense. If you know your marketplace, chances are you will know all of the nuances about that investment area. But this new study suggests that the farther you are away from that sort of investment, the better the investment does.

In a diversified portfolio, you probably own a few funds that you are taking a risk with - something in the emerging markets, an international fund or a hybrid of the two. Good advice has always suggested that some limited exposure to what occurs in far-away places adds some seasoning to an otherwise straightforward portfolio. Little did many of us know until recently was that this sort of investment will do better because it is so far out of our field of expertise.

Perhaps the worst thing that can happen to a mutual fund manager is the reaction of the herd or herd mentality. Once the herd begins to move in one direction or the other, hence the description, there is little anyone can do to stop the momentum from gaining speed. I don't need to tell you that the most recent example of just such a herd reaction was during the most recent downturn. Once the well-informed investors began to retreat, other investors, via the alerts from the media, began to follow.

For a mutual fund manager, this is the worst of all possible events. Keep in mind, most mutual funds don't keep a lot of cash laying around. When the occasional investor exists, they sell something and pay them off. But when an entire herd heads for the door, the selling simply opens the market wound wider and the bloodbath begins.

Hedge funds don't allow this to happen which allows them to take a position that might be contrary to what the markets are doing. In other words, they can buy what you don't want and sell what you think is hot and make money on either end of the investment equation. But the ability to do this is made possible by the knowledge that their underlying portfolio is not affected by the herd. That's not to say that their investors don't panic, but the lock-up keeps them from mucking up the plan - for the hedge fund manager and the other investors - by trying to head for the door when they probably should be buying more.

Now what Ferreira, Massa and Matos discovered was a sort of geographic lock-up. The farther away from the fund the actual investor was, the higher the likelihood that they would allow the fund, with the local address to do what it needed to do without interference. In other words, the less you knew about what was happening, the better the fund was likely to do. Distance turned these far-away funds into de facto hedge-funds.

In a nod to the hedge fund industry, they wrote: “This intuition is similar to the one proposed for hedge funds: Hedge funds take advantage of mutual fund investors’ fire sales. When mutual funds are forced to sell to meet redemption calls, hedge funds buy the assets liquidated at fire sale prices (Chen, Hanson, Hong, and Stein, 2008). The fact that mutual funds intermediate a way higher fraction of asset under management than hedge funds suggests that this effect represents a large-scale “limits of arbitrage” phenomenon, way more important for the economy.”

In other words, mutual fund managers who essentially swoop into a location, buy what they think is a good buy (not saying that their research is faulty) and fly back to the home office, lack the physical understanding that a geographic embeddedness offers. In other words, if you live there, you know better what is going on. Even in a global economy with the world seemingly wired to give you information in a split second, being somewhere is still better in terms of investments.

As I said when I began, this is not a recommendation to put whatever you have in places far away from where you live. But rather a shortfall of what we understand about where we invest. If there had been lock-ups in place for mutual funds, there is a distinct possibility that the downturn would not have been as severe. While hedge funds use lock-ups to prevent investors from forcing redemptions of what would be illiquid investments, mutual funds could use the same rule to control herd mentality and protect the patient, long-term investor in the process.

Are Mutual Funds that Short a Good Idea?

Most investors don't understand the idea of a shorting an investment. The concept is relatively straightforward: an investor essentially bets that a stock will go down and if it does, profits from the fall. Going long does the opposite, wagering that a stock will move higher. This was formally the purview of the hedge fund, those high dollar investor clubs with equally high fees, that sought to use every market strategy available to gain ground for those investors.

As I said, this was formerly something of an investment style that was not available to mutual fund investors. But this is a different investment world and the mutual fund industry, in its own way, acknowledges that trend with a group of funds that offer a defensive footprint in the market. In other words, rather than simply assuming that all stocks will go higher, they believe their research and expertise can locate stocks that move in the opposite direction.

Studying an online MBA with an emphasis on finance can get you up to speed on mutual funds. If you don't have such a background, this information will help you understand shorting your investments.

The question is: is this a good investment for your portfolio and more specifically, how do you avoid the lure of their promise to do better than traditional funds or even ETFs? It's no easy feat launching a mutual fund and even though some appear new, they can take a year or more to hurdle regulatory requirements before the first share is offered.


In almost every instance, when it comes to investing in mutual funds, the basis for your decision rests on not only the tenure of the fund manager, but the length of the fund's performance. This backward looking approach doesn't always serve the investor well when it comes to picking a fund based on what it has done compared to where it is now, nor does this sort of comparison reveal the true nature of the fund's ability to best the overall marketplace, a field now numbering over 8,000 potential offerings.

When times are bad, as was the case twice during the last decade, good years can be wiped from the investors view, replaced with averages that make the fund appear lackluster.

New funds don't have that sort of problem. They're new, with no history and no track record. Just a charter and a manager. So new investors are forced to look at the fund family (which provides research and oversight) and the previous experience of the person(s) at the helm. This is no easy trick and requires a leap of faith. Not the soundest of advice; more like a word or two of caution.

According to Dan Culloton, associate director of fund analysis with Morningstar: "They're [long-short mutual funds] responding to the market fears and frustrations over the past 10 years. A lot of it is just pure-and-simple rearview mirror product management." One hundred and fifty new funds have decided that this is a market worth exploring.

Among the new offerings, seventeen are focused on emerging markets. This particular sector is teeming with potential and just as many problems. It is those problems, which can range from anything like political unrest to poor financial infrastructure are widely thought to be the main drivers in such an investment space. And the risks in some of those bets were indeed high. These new funds (some of which can be found here and do not constitute any recommendation to buy) have done quite well for themselves in the years following the downturn in the US stock market.

There is also opportunities to play both sides of the extremely volatile commodities markets. Many of us have watched with great interest the demand for some commodities and understand the risks involved. Yet we a lured by the potential returns this sector can offer, looking for some way to mediate those risks.

Enter the commodity mutual fund designed to play off of those investor fears, the world-wide demand for many commodities in short supply, and the ability to find profit where other investors may not yet be. And because they short securities as well, they bet some investors will not be there for long (the reasons vary from currency policy changes to the perception that something may be overbought and ripe for a bubble pop). You can find a list here.


But are these funds right for you? Yes and no. Yes if you are looking to fill a small corner of your portfolio, perhaps as little as 5-10%. There are great deal of more traditional investments that allow you to see where the fund has been and where it is headed. These still remains the best tools for making a decision on where to invest your money. And no, if you are easily swayed by the relatively high returns these funds have been providing investors over their short-life spans. That temptation can easily allow you to increase those percentages to too high a portion of your portfolio, eliminating the best diversity plans.

And since a vast majority of us will be using or retirement portfolios (401(k)s and IRAs) to do this sort of investing, special caution is worth considering.