Attack of the Clones (Again)

By: Marc Hogan, Business Week
Published: December 4, 2006

It’s official!  We’ve run out of colourful headlines about hedge fund “clones”.  What was once a headline editor’s dream has quickly become a clone itself.  (see “An attack of the clones could spell end of 2 and 20” – Nov. 15).  Hedge Fund cloning researcher Harry Kat has even dubbed an upcoming conference presentation “Attack of the Clones“.  “Attack of the Clones” narrowly edges out The Economist’s “Send in the Clones” as the most cheesy headline on this topic.

In any event, Business Week puts a main street spin on the topic that speaks to individual investors.

“Indexing may not appeal to current hedge fund investors, though, some analysts observe. “The typical hedge fund investor may not wish to effectively trade in their Ferrari for a potentially more reliable—and arguably boring—Buick,” says Jeff Keil, principal at fund consultancy Keil Fiduciary Strategies.”

In this article, Merrill Lynch describes their “Attack” strategy as being similar to an index fund.

“Merrill’s Factor index became available to institutional investors several months ago, and the company says it manages a “significant” amount of assets in products tied to the index. ‘We think about it like an S&P 500 index fund, only related to hedge funds,’ says Steve Umlauf, a Merrill managing director in global markets. ‘Like an index fund, we believe it needs to be developed in a liquid, low-cost, transparent form.’

While this analogy may ease main street adoption of hedge fund clones, it is inaccurate.  While an index fund invests in a representative set of securities, a hedge fund clone uses algorithmic trading to invest in a very select group of generic securities.

“The index is built from six underlying components: the Standard & Poor’s 500 index, MSCI’s EAFE index, MSCI’s Emerging Markets Free index, the U.S. Dollar index, the Russell 200 index, and the London Interbank Offered Rate. Merrill uses an algorithm, reweighted monthly, to replicate the performance of several hedge fund benchmarks.”

While this article can be firmly placed in the “hedge funds are a rip-off” camp, it does make an important point about the continuing value of real hedge funds.

“With their new offerings, Merrill and Goldman extend the passive-investing phenomenon to the risk-taking hedge fund community. Eventually, the products may give individual investors another way to diversify their portfolio, but anyone hoping to match the returns of the top hedge funds will probably still be stuck paying champagne prices for the work of a real, live manager.”

As we wrote yesterday, hedge fund clones are only valuable if you believe your hedge fund-picking skills are the same as a dart-throwing monkey (which, according to academics, is actually the case for all of us in the long run).

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