Will Hedge Fund ETFs Outperform Hedge Funds?

| About: IQ Hedge (QAI)

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 (NYSEARCA: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.