Hedge fund clones are proving their mettle. A study conducted by Swiss academics concluded that due to the high correlation between these so-called synthetic funds and hedge fund indexes, clones can serve as a substitute for the traditional high-cost, high-barrier hedge fund.
Much like an index equity strategy, these funds focus on "beta," which some say accounts for 80% of hedge fund returns, explains Nadia Papagiannis, analyst at Morningstar Inc. (NASDAQ:MORN). Their goal is to mimic hedge fund indexes using a statistical model or algorithmic trading.
Three years ago, when these products hit the market, they were met with healthy skepticism. Without real-world, tried-and-true performance data, investors were wary to pile in, despite promises of better liquidity, more transparency and lower fees. But now, armed with a solid track record, clones are gaining more clout. Thirteen out of 20 hedge fund clones tracked in the study outperformed hedge fund indexes. (This is good and bad, as it shows that exactly matching the index -- the goal -- was not totally achieved. However, the outperformance was enough to detract from conclusion that clones can serve as replacements.)
Because of their relatively good performance, and their delivered promise of lower fees -- clones generally charge a flat rate of 1% of assets under management -- "many traditional hedge fund clients may also be tempted to defect," writes Christopher Swann of Reuters.
But, as Swann also points out, clones have a long way to go. They were hit hard by the credit crunch; their high liquidity left them vulnerable to redemptions, and approximately 80% of their collective AUM was withdrawn. Now, clones' assets account for less than 1% of total hedge fund assets.
As more evidence surfaces that hedge fund replicators can indeed deliver hedge fund-like returns as well as portfolio diversification, could they give traditional hedge funds a run for their money? From here, it seems like only the average-performing hedge fund manager has anything to worry about; the John Paulsons of the world are still very safe. - Sara Behunek
Download the study here
Read Christopher Swann's column here
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