IndexIQ CIO Bruno: A Different Way to Track Hedge Funds

Mar.27.09 | About: IQ Hedge (QAI)

Salvatore Bruno is chief investment officer at IndexIQ Advisors LLC. Prior to joining the asset manager and index provider, he was a portfolio manager at Deutsche Asset Management. Before that role, Bruno was the head of advanced quantitative research at DeAM.

On Thursday, IndexUniverse's Murray Coleman caught up with the busy CIO traveling in Philadelphia. Among other topics, they discussed the firm's launch of the IQ Hedge Multi-Strategy Tracker ETF (NYSEARCA:QAI), the first exchange-traded fund to mimic hedge fund strategies. (See article here.)

IU: Is the new ETF taking a totally passive approach?

Bruno: It's fair to say that this is a rules-based methodology. But it does rebalance more than a traditional passive investment. It rebalances every month. But it's passive in the sense that it doesn't incorporate subject views on where assets should be allocated.

IU: Does the ETF follow a similar index as the mutual fund created by IndexIQ last year?

Bruno: It is similar in terms of methodology. But given the differences in the regulations between a 40-Act mutual fund and an ETF, there are some slight differences. But the underlying processes are the same.

IU: You've created essentially six different subindexes based on different hedging strategies. How do you decide weightings for each subcategory?

Bruno: The weightings are a result of a proprietary rules-based optimization process. We look at trailing returns of each of the six strategies. And we compare the level of returns, volatility and correlation of each of those strategies to a broad hedge fund index. That broad index is the CS Tremont Non-Investable Hedge Fund Index. Then we find the best combination of the strategies to achieve our objectivity of high returns, low volatility and high correlation to hedge funds.

IU: What are the weightings to each strategy in the ETF now?

Bruno: The weights are approximately 33.33% each in equity market-neutral, fixed-income arbitrage and event-driven strategies. We also have a -16.67% on long-short, and the remaining weights are split among global macro and emerging markets. The specific ETFs we're holding and their weights are posted on our Web site daily. [See table below for QAI's complete holdings.]

IU: How are ETFs used to represent different asset classes held by hedge funds?

Bruno: We're looking for ETFs that meet minimum liquidity and asset size requirements to make sure they're truly investable. Then, we look at asset class exposures and risk premiums of hedge funds. So we're trying to find the optimal ETF or combination of ETFs that match up the closest to those asset class and risk premium exposures of hedge funds.

IU: Does the ETF take on similar characteristics of a 130/30 hedge fund?

Bruno: The ETF will not because it doesn't have any short positions in its portfolio. We do, however, use inverse ETFs to generate short exposures. That's different from the mutual fund, which actually shorts securities and uses proceeds from those transactions to go long. This is a prime example of the difference in implementing basically the same strategy but in different vehicles—a mutual fund compared to an ETF.

IU: In a nutshell, what exactly are you trying to deliver with this new ETF?

Bruno: We're trying to provide a vehicle that will give investors access to risk-adjusted returns similar to those of hedge funds. We're also trying to provide similar levels of diversification to broad equity markets.

IU: How non-correlated is this ETF's benchmark to the broader stock market?

Bruno: The CS Tremont index has a correlation of between 50-60% to the S&P 500. We expect our ETF to have similar levels of correlation to the S&P 500. We have live returns on the IQ Multi-Strategy Index since 2007. But including live and backtested returns, it has generated about a 4.86% average annualized return in the past five years through February. And during that same period, the average annualized volatility is less than 6%. By comparison, the S&P 500 returned -6.63% with significantly greater volatility.

IU: With slightly more than 9,000 hedge funds in the U.S., how can you accurately categorize all those funds into six distinct styles?

Bruno: We've chosen to outsource that level of analysis to CS Tremont and Hedge Fund Research Inc. We work with data at the strategy level, not at the fund level. That's an important point because at the fund level, there's a lot of specific fund manager risk, which is difficult to model. We're actually able to better identify the common factors driving hedge fund returns without being distracted by the noise of manager-specific risk.

The Complete Portfolio Of QAI (Through March 25)




Barclays Agg. Bond



Barclays 1-3 Treas.



iShares Emerg.



Vang. Total Bnd



PowShs G10 Cur



iBoxx High Yield



Barclays Short Treas



SPDR High Yield



Vang. Short-Term



SPDR 1-3 Month



Vang. Emerg. Mkt



UltShrt Russ 2000



Barclays Treas. Inflat.



UltShrt EAFE



PowShs Commod



UltShrt Real Est.



SPDR Cap. Agg.



UltrShrt Euro



Click to enlarge

Original source