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June 07, 2005
Gabelli Asset Management Launches SRI Hedge Fund Focused on Catholic Values
    by William Baue

The fund uses short-selling and merger arbitrage strategies, and screens out companies involved in abortion, contraception, stem cells, and pornography, as well as the top 50 defense contractors.

Since Alfred Winslow Jones created the first hedge fund in 1949 by combining short-selling, leveraging (or borrowing), incentive fees, and shared risk strategies, the number of hedge funds grew to 200 in 1968, shrank to only 68 in 1984, then mushroomed to about 4,000 in 1999, according to hedge fund consulting firm Tremont Partners. Of the 8,000 or so hedge funds now on the market, however, only a handful practice socially responsive investment (SRI) strategies, including the Good Steward Fund (a Catholic "fund of funds" hedge fund), an environmental hedge fund from Winslow Management Company, and four SRI hedge funds from Green Cay Asset Management. Last month saw the addition of one more SRI hedge fund, focusing on Catholic values, launched by Gabelli Asset Management Company (GAMCO).

The strategy fuses two of Gabelli's longstanding strengths. Gabelli launched its merger arbitrage hedge fund, the strategy upon which this new fund is partly based, in 1985. Two years later, the firm began practicing SRI, and now manages approximately $700 million in three SRI portfolios (a large-cap value fund, a small-cap value fund, and a traditional value fund) as separate accounts.

The gap in SRI hedge funds inspired initial interest in creating the fund, according to Chris Desmarais, senior vice president and director of socially responsive investments at Gabelli. This market opportunity was subsequently bolstered by demand from Gabelli's SRI clients, a large portion of which come from the Catholic institutional investment community, hence the religious orientation of the screens.

The screens exclude companies involved in abortion, contraception, stem cells, and pornography, as well as excluding the top 50 defense contractors. Gabelli performs the research behind these screens in-house, as well as using the SIMON database, a web-based portfolio screening tool from the Social Investment Research Service (SIRS) of Institutional Shareholder Services (ISS).

The primary hedging tactics employed by the new fund (formally known as GAMCO SRI Partners) include long/short techniques as well as merger arbitrage. The former strategy involves taking long-term investment positions in stocks selling at a discount to profit on the expected rise in share price; shorting involves selling stocks trading at a premium and then buying them back after they fall in share price, thus profiting off the drop in value.

"The long/short strategy is designed to achieve more consistent returns with lower volatility than a long-only portfolio," Mr. Desmarais told "Small- and medium-sized companies offer particularly attractive fundamental values for our method of investing."

Merger arbitration involves simultaneously buying and selling stocks of two merging companies to profit from the price differential (or "spread") between the market price of the merging companies and the value ultimately realized after the transaction, which is typically higher.

"[C]atalysts, mainly in the form of merger and acquisition transactions and corporate restructurings, are occurring at an increasing rate," states Gabelli. "We expect these trends to continue over the next several years."

The average merger arbitrage holding period in the portfolio is 45 to 60 days. Gabelli intends to constitute the portfolio with 60 to 80 core holdings in both the long/short and the merger arbitrage strategies, with a net leaning toward long holdings. The minimum investment is $500,000, with a one-year lock-up during which time investors cannot redeem shares. The fund charges a management fee of 1.35 percent as well as 20 percent of the profits.

This last arrangement is in keeping with Mr. Jones, the inventor of hedge funds, who introduced this scheme in 1952 as an incentive to hedge fund managers to produce superior returns. Tremont Partners, the hedge fund research firm, attributes hedge funds' edge over standard investment vehicles such as mutual funds in large part to incentive-based compensation.

"Incentive based compensation is a powerful lure for investment talent," said Mario Gabelli, who founded GAMCO in 1976. "Twenty percent of the profits can be a very good deal even relative to a big Wall Street salary."


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