Will Hedge Fund ETFs Outperform Hedge Funds?

On paper, the hedge fund industry is one ripe for a challenge from the ETF industry. Hedge funds have high manager risk, and were previously out of reach for many investors due to high minimum investment requirements and exorbitant fees. Enter the hedge fund ETF.

The First Ever Hedge Fund ETF: QAI

The IQ Hedge Multi-Strategy Tracker (QAI) began trading last month as the first ever hedge fund ETF. Of course, it’s not the first time someone has used ETFs to mimic hedge funds. Many people have utilized ETFs to build their own hedge funds, so to speak. Though, this strategy requires active research and management, and wouldn’t necessary track the publicly available hedge fund activity, which QAI does.

QAI is also unique in that it doesn’t try to execute a particular hedge fund strategy, but rather tries to to replicate the returns of the IQ Hedge Multi-Strategy Index, which tracks the entire hedge fund universe. Essentially, it buys the entire hedge fund market, which includes long/short equity hedge funds, global macro hedge funds, market neutral hedge funds, event-driven hedge funds, fixed income arbitrage hedge funds, and emerging markets hedge funds. It doesn’t invest in hedge funds directly, but instead in other instruments which can allow it to mimic their returns.

Advantages of Hedge Fund ETFs over Actual Hedge Funds

The hedge fund ETF is an intriguing product, because, assuming it can actually mimic hedge fund returns and behavior, it holds many advantages over an actual hedge fund:

• Fees: Compare .75% (hedge fund ETF) vs. “2 and 20″ (which effectively could range from 2% to 10+% in any given year!).
• Manager Risk: Compare tracking an index (hedge fund ETF) vs. trusting a particular hedge fund manager to meet or exceed his peers (and not giving your money to Bernie Madoff).
• Minimums: Compare investing any amount (hedge fund ETF) vs. investing the fund-minimum in a hedge fund (only available to very high net worth individuals in most cases).
• Withdrawal/Redemption/Transaction Fees: Compare the ability to trade any time you want and pay only a broker transaction fee ($7 at Scottrade for instance) vs. paying redemption feeds and possibly facing other restrictions with a hedge fund.
• Transparency: Compare virtually total transparency (hedge fund ETF) vs. the opacity of a hedge fund.
• Regulation: Compare a very clear regulatory environment (hedge fund ETF) vs. the little federal oversight over hedge funds.

Of course, we’ll need time to determine how useful hedge fund ETFs really are. But we have plenty of historical hedge fund data to compare them against; so the next 12-24 months should paint a clearer picture.

Disclosure: At the date of publishing, the author currently does not own any shares of the specific stocks mentioned.

Comments

[Daniel Moser:]

There are no advantages to this garbage ETF you talk about. It is a scam to claim that this ETF will track a multitude of hedge fund strategies. Virtually nothing about this new ETF actually involves the same risks inherent in most of the hedge fund strategies. Thus there should be no real expectations for this ETF to track what it claims to track. This ETF is a joke that is just going to result in small investors getting pissed off once they see the majority of hedge fund strategies appreciating 10-15% over some time period and yet they have experienced only 5% appreciation. Why? Because the this new "hedge fund ETF" simply holds a multitude of fixed income ETF's. In my opinion this new ETF isn't even a half ass attempt to give ordinary investors a decent product. It is a marketing gimic designed to do little more than generate fees.

Make no mistake about it, I am not saying investors will lose money by purchasing this ETF. This new ETF might go up or it might go down, and I don't particularly care which. This new ETF might have a positive return in 12-24 months, but it won't look anything like hedge fund returns.

There is a much better product put out by AQR Capital with the ticker symbol: ADANX. It is a mutual fund structure that actually invests in funds, stocks, and strategies that will more likely capture the passive returns in hedge fund strategies. AQR has some incredibly intelligent people working for them. Not to mention the fact that they are legitimately trying to create a product that behaves the way they say it behaves. I cannot say the same thing for this stupid ETF and the people that have rolled it out.

Apr 22 09:21 AM

[Eversar:]

Top Holdings(as of 04/21/2009)
Name Weight
ISHARES BARCLAYS AGGREGATE 23.85 %
ISHARES BARCLAYS 1-3 YEAR TR 18.15 %
ISHARES MSCI EMERGING MKT IN 11.70 %
VANGUARD TOTAL BOND MARKET ETF 8.37 %
POWERSHARES DB G10 CURRENCY 8.00 %

www.indexiq.com/etfs/e...

Apr 22 11:52 AM

[hatarakiman:]

Two things come to my mind.

1st. I am not sure if they use correlations to find the underlying components of the FoF. Predicting the future is not like predicting the history, so it takes time to see if it really works.

2nd. The major components are Bonds, Stocks, and Currencies. According to the Modern Portfolio Theory, the result of the portfolio would be inside the efficient frontier determined by those components. But the (risk,return) of the FoF is outside the efficient frontier determined by bonds and stocks from the past experience (am I right?). Let's see how it goes.

Apr 25 08:44 AM