Hedge fund clones calling in reinforcements for “attack” on funds of funds

It used to be that the term “hedge fund clones” referred exclusively to so-called “hedge fund replication” (a.k.a. “alternative beta) strategies.  We noted in December 2006 that the term was already well worn.

But now Man Investments has borrowed the term to describe not just alternative beta strategies, but also other emerging strategies such as 130/30, investible hedge fund indices and “permanent capital” (exchange-listed shares in hedge funds).  What’s the common link?  They amount to what Man calls “hedge fund alternatives” that address the barriers of “high fees and comparatively poor liquidity” that prevent many institutions from investing in hedge fund strategies.

In a report issued this month called, Attack of the ‘hedge fund’ clones: Investable indices, Alternative beta, 130/30, Permanent capital“, Man ties together these loosely related concepts into one framework that is similar in its intent to this 2007 article, but with a lot more detail.

As a result, this white paper is a great overview of alpha-centric investing that is succinct and easy to read – especially if you like smiley face icons…

This table goes on to list the replicability of all major hedge fund sub-strategies.  Hedge fund replication enthusiasts will recognize much of this data from its various original sources (most of which are available in our Hedge Fund Replication research dossier.  But for the rest of us, this chart is a good summary.

The white paper goes on to list all the major hedge fund replication strategies and tracks the performance since last summer for all strategies whose performance is publicly-available…

Of course, you can’t tell from the above chart which strategy is actually better able to “replicate” hedge funds.  Even displaying these funds as a horse-race highlights the irony in most of their marketing messages.  Are they designed to “replicate” or “perform”?  And if they are truly meant to “replicate” some hedge fund index, then which one?

The paper shows, for example, that at least two major offerings blew away the HFRX Index (a daily-priced, investible index that generally performs quite a bit worse than the non-investible equivalent, see related posting), and just about matched the HFRI Fund-of-Funds Index (which also tends to underperform the main single-manager hedge fund indices due to the presence of the second layer of management fee charged by the fund of funds).

The report also cites research by AllAboutAlpha.com and Terrapinn that investor interest in hedge fund replication is all about liquidity and fees:

The report goes on to say more about investable indices, 130/30 and permanent capital.  But despite all the potential benefits of these “hedge fund alternatives”, nothing beats the real thing:

“FoHF have been and will continue to be an integral part of hedge fund investing. While investors do have alternatives such as direct investing, investable indices, 130/30 or alternative beta replication, FoHF are still the most suitable route for most investors aiming to include hedge funds in their portfolios. This is the case for both private and institutional investors. The long list of casualties in the hedge fund industry has also driven allocators toward the security and diversification provided by a FoHF. On the other hand, as the FoHF industry matures and partially converges with long only asset management, FoHF are having a harder time beating the average return for all hedge fund strategies. Therefore the fees that FoHF charge have to make economic sense. We believe investors should weigh up the fee structure with the value added of the FoHF manager such as fund picking, asset allocation, timing of subscriptions and redemptions, risk management, portfolio construction and continuous monitoring.”

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One Comment

  1. Jerome Abernathy
    July 22, 2008 at 8:12 am

    Our studies show that the vast majority of diversified FoHF returns can be attributed to alternative beta.

    So the real challenge for FoHF (and the opportunity for alternative beta) is to justify the high aggregate fees they charge for the alternative beta portion of their returns.

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