Recent performance of HF clones shows they “were attractive during the crises of 2008”

cloneprotectionAh, the good old days – when the hedge fund “secret sauce” was revealed and suppliers set about developing the products that would bring it to investors the world over under the moniker “hedge fund cloning”.  But as Swiss researchers Erik Wallerstein, Nils Tuchschmid and Sassan Zakerc note in a recent paper called “How do hedge fund clones manage the real world?”:

“Some years ago hedge fund replication was a much discussed topic on the hedge fund horizon. A credit crunch and some hedge fund Ponzi schemes later, the attention has turned elsewhere.  2008 performance of broad hedge fund indices where dismal at best. This did not bode well for selling pitches to persuade investors to turn to funds which replicate this performance.”

However, the trio goes on to argue that the $2 billion hedge fund replication business is far from dead.  Hedge fund replicas, they say, “…have several unique and interesting features, many which where attractive during the crises of 2008.”

They analyze the recent performance of 21 hedge fund clones from 17 companies covering the full spectrum of replication techniques from factor replication to distributional replication to mechanical replication.  (see the “Alternative Beta and Hedge Fund Replication” category at the right side of this page for extensive coverage of these topics).

Here’s how the 21 fund stack up from March 2008 to May 2009 (chart based on data in paper)…


At first glance, you might be impressed that some replication products actually managed to squeeze out a positive return last year.  If so, you’d be disappointed to learn that the biggest winners were actually short versions of hedge fund replicators – designed to take advantage of downturns in the hedge fund industry.   However, there were some replicators, notably the Aquila Capital Statistical Market Neutral Arbitrage Fund (distributional approach – see related post), the Desjardins Global Asset Management Synthetic Alternative Investment Fund (also a distributional approach – see related post) and the Fulcrum Alternative Beta Fund (a factor-based approach – see related post).

Overall, the replicators performed admirably.  The blue diamond above represents the S&P 500 over the same period and the green diamond represents the HFRI fund-weighted composite index.

As you can see from the chart below from the paper, 100% of the replicators beat the S&P 500 (in blue) during the time period analyzed (March 2008 to May 2009.)



Interestingly, many hedge fund replicators avoided the deep drawdown experienced by the HFRI (in black), but have underperformed the index since last 2008 as the HFRI has come roaring back.

The authors conclude the report with a comment on the state of the hedge fund replication business and a word of warning about one of the value propositions of hedge fund replicas:

“Investors should also question the promise of better transparency in replication products. The trend seems to be that replication models are becoming increasingly complex and it is necessarily a need to also understand why models allocate to certain assets. The distribution approach is a case in point. While the products in this survey indeed have generated the best performance it is not in our view straight forward to understand under which market conditions this method will deliver high returns.”

As we have argued before on these pages, the true objective of hedge fund replication products should, in theory, be to replicate the hedge fund industry (e.g. the HFRI), not to beat it.  On those grounds, most “replicas” seem to fail.

However, this assumes that the hedge fund index adequately represents the performance of hedge fund strategies.  But as noted academic Bill Fung has pointed out (see related post), hedge funds often succumb to extra-investment factors such as liquidity and panic selling that their strategies do not necessarily capture.  If these issues were not adequately captured by replicas of hedge fund trading models, then this could explain the under-performance of hedge funds vs. their theoretical potential.

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  1. Harry M. Kat
    September 10, 2009 at 4:39 pm

    As the “father” of distributional replication, I am extremely happy with this research paper. Being more complex than other techniques, distributional replication has been slow gaining acceptance. Now, however, we have the real life performance of 2 products based on it defying all criticism and clearly showing how robust the technology is. Quoting from the paper (page 9): ” the two (products) based
    on distribution approach are singled out as to have the highest returns and belonging to the group of four products with the lowest volatility.” It is important to note that there are big differences between both products though. Fully in line with its explicit risk targets, the Aquila Capital SVMN fund, which uses our FundCreator risk management system, generated zero correlation with stocks, bonds and commodities. The DGAM product on the other hand exhibited very high correlation with these asset classes, much in line with other replication products. Building good diversifiers is not as simple as most people think

  2. Rabbe Ekholm
    September 28, 2009 at 2:14 pm

    In September 2009, TrueBeta launched its independent hedge fund replicator.
    The express objective of TrueBeta is to replicate the performance of the hedge fund industry, no to beat it (referring to your comment above). Simplicity and transparency of methodology and construction are also specific design objectives.

    Correlation with the HFRI equal weighted composite over a 5-year period is 0.93, with an annualized tracking error of 3.07%. Skewness and kurtosis are virtually identical to the HFRI index.

    You can find more detail on methodology and performance on

    Rabbe Ekholm

  3. Pierre Laroche
    October 8, 2009 at 7:50 am

    A good paper from independant researchers. The message is clear: HF index replicators are certainly worth looking at. Also, I can add that we see more and more FoHF managers using them to manage their excess cash or as the core components of core-satellite FoHF that offer more efficient exposure to the HF industry.

    Pierre Laroche
    Innocap Investment Management

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