“Your clones are very impressive. You must be very proud.”
– Obi-Wan Kenobi, Star Wars Attack of the Clones, 2002
Star Wars fans may remember Obi-Wan Kenobi’s famous words after cleaning up by shorting Death Star sub-prime debt in a galaxy far far away then hedging it with a Sith-Jedi total return swap. But was Kenobi serious, or was he just being flippant? Was he really impressed with the clones?
French business school and research institute Edhec also takes a moment this week to pay tribute to the burgeoning ranks of clones – these ones of the hedge fund variety. In this article, Edhec’s Walter Gehin discusses the key players in the field, but like Obi-Wan, is somewhat obtuse about his personal feelings on the subject.
The piece contains a great listing of all the current (major) hedge fund clone offerings (e.g. ART, ABI, ARB, T-Rex, Altera, MAST, ABS – seriously, these are all real names) and divides them into two main categories: factor-based and rules-based.
While he seems to agree with the general concept of factor replication, Gehin strikes a note of skepticism:
“Fung, Hsieh and Naik are the academics that have given the most extensive support to this method. They have teamed up with JP Morgan, State Street Global Advisors, and BlueWhite Alternative Investments. This kind of partnership undoubtedly adds to the credibility of the replication tools and is exploited as a marketing argument.”
Gehin highlights that factor models are essentially driven by looking out the rear-view mirror and therefore they take time to recognize a changing environment.
He identifies a hybrid somewhere between linear factor modeling and pure dynamic trading (“rules-based” strategies) and places Partners Groups’ ABS fund and Morgan Stanley’s Altera in this category.
Pure rules-based trading strategies include Merrill’s offering (and, we might add, Deutsche Bank’s – see related posting). As Gehin points out, these trading strategies start to look a lot like actual hedge funds. His observation about Merrill’s offering is matched by our observations about Deutsche Bank’s, which exploits seven trades the firm says are the bread and butter of many hedge funds. (Deutsche Bank admits that it’s often asked if it has simply created another form of quant fund.)
The article also points out that so-called “distributional replication” approach has only recently been offered as a stand-alone fund (by Canada’s Desjardins Global Asset Management – see related posting).
Finally, Gehin seems to endorse the observations made by Kat (see related posting) that most replication models (of both the factor-based and rules-based variety) aim to mimic only broadly diversified indexes of hedge funds. In other words, targets that “(do) not give access to one of the main advantages of hedge funds, namely risk diversification.”
If you’re looking for something to send to a colleague that quickly and succinctly summarizes the hedge fund replication landscape without the usual colorful flourishes, this is the one to send. Obi-Wan would be proud.