Tag Archives: hedge funds

Does Hedge Fund Replication Work?

Just days after the stock market hit its March 2009 bottom, IndexIQ, a tiny index provider, launched its first exchange-traded fund, the IQ Hedge Multi-Strategy Tracker ETF (QAI). As far as attracting investors, the timing proved inauspicious. Most investors were shellshocked after witnessing the stock market plummet more than 50 percent in 18 months. However, inside the ETF industry, the fund’s hedge fund replication strategy drew much interest. In April, the ETF won Most Innovative ETF and its eponymous index won Most Innovative Index at the 9th Annual Closed-End Funds & Global ETFs Forum, the first time a single firm won awards in both categories.

It’s no wonder. Hedge funds are sexy. These aggressively managed portfolios use sophisticated strategies to generate market-beating returns, otherwise known as alpha. Also, they’re very exclusive. Called “mutual funds for the super rich” by Investopedia, hedge fund investors need to be accredited. This means investors must not only be knowledgeable, but they must have a net worth greater than $1 million and make a certain amount of money. Unlike mutual funds, hedge funds aren’t regulated, so they have the flexibility to invest in many kinds of assets.

Hedge fund ETFs like QAI were supposed to solve all that. Democratize the space. Lower costs. Increase transparency.

It was “hedge funds for the rest of us.”

But do they deliver?

Now that the IQ Hedge Multi-Strategy Tracker and its brother, the IQ Hedge Macro Tracker ETF (MCRO), have passed their first birthdays, it’s possible to perform data comparisons to see if they actually deliver. Do these funds provide the pattern of returns that investors want when accessing the hedge fund space?

The first thing one needs to know is that, contrary to conventional wisdom, hedge fund ETFs aren’t charged with maximizing return on investment. They follow the strategy of the original hedge funds, reducing risk and minimizing losses by shorting and holding a combination of asset classes not correlated to the broad market. Of course, reducing risk means dampening potential profits, which means when the S&P 500 Index goes straight up on a bull rally, hedge fund ETFs will lag the market’s returns.

And that’s exactly what happened for the 12 months ending June 30: When the S&P 500 leapt 14.4 percent, the IQ Hedge Multi-Strategy Tracker inched up 2.2 percent and the IQ Hedge Macro Tracker gained 3.9 percent.

“Nothing is designed to shoot the lights out,” said Adam Patti, chief executive officer at IndexIQ. “I look at stress periods in the market as where hedge funds should be doing well.”

The hedge worked during the second quarter of 2010 when the S&P 500 tumbled 11.4 percent into a market correction. QAI slid 2.6 percent and MCRO lost just 2.1 percent. The ETFs also reduced volatility for the six months ended June 30. The S&P fell 6.7 percent during that period, while the QAI and MCRO posted negative returns of 2.5 percent and 2.3 percent, respectively.

“They are trying to produce a return pattern of the average hedge fund,” said Kevin Malone, president of Greenrock Research, a Chicago research firm. “The reason to consider this is to get a return pattern different from stocks and bonds; better than bonds but not as good as stocks.”

Originally published in ETF Report. For the full story click here.

ETF Tracks Two Hedge Fund Strategies

Unlike the mutual fund industry, where the line up of funds seem the same from fund house to fund house, in ETFland originality can make or break you. IndexIQ continues to build the niche of following hedge funds without actually owning hedge funds.

The Rye Brook, N.Y., company launched the IQ Hedge Macro Tracker ETF (MCRO) to track the index of the same name. The IQ Hedge Macro Index combines both Global Macro and Emerging Markets strategies, two strategies that historically have performed well after significant market dislocations. IndexIQ previously released the IQ Hedge Multi-Strategy Tracker ETF (QAI).

Global Macro hedge fund strategies look for investment opportunities around the globe where they can find market inefficiencies and dislocations amid a variety of asset classes including stocks, bonds, commodities, and currencies. Emerging Markets strategies attempt to identify investment opportunities in growing emerging market countries, including the BRIC nations of Brazil, Russia, India and China.

It looks like the fund seeks to get emerging market returns, a traditionally volatile market segment, with less volatility. So far in 2009, emerging markets equities have performed well.

The IQ Hedge Macro Strategy Tracker ETF doesn’t invest directly in hedge funds. Instead it uses data from hedge fund strategy returns. “It uses factor and quantitative analysis to replicate the returns and common risk factors of hedge fund investing strategies, using existing Exchange Traded Funds as the building blocks of the portfolio.”

Got that kids?

It doesn’t invest in hedge funds. It just tries to replicate their strategies by using existing ETFs. It’s a fund of funds. Here’s the portfolio on March 31, 2009. Scroll to the second page.

The typical hedge fund charges 2% of your assets and 20% of your profits. That 2% is still a nice chunk of change when your fund loses money. The MCRO ETF charges an expense ratio of 0.75%. Actual operating costs were 1.14%, so they’re cutting that to keep competitive with other ETFs.

IndexUniverse, which calls these ETFS “hedging strategies at bargain-basement prices” made a nice chart of the funds composition at the end of last month.

ETFs Will Inherit the Earth

This will be the first of many times I say this over the coming months. I think the ETF will be one of the few beneficiaries of the financial destruction being seen in both the hedge fund and mutual fund industries.