Will Hedge Strategy ETFs Replace Hedge Funds?

A blogger named Michael Johnston posed an interesting question in asking whether, after the closing of several prominent hedge funds, ETFs that try to replicate hedge fund strategies will replace hedge funds.

The first one to come to mind is the IndexIQ Multi Tracker (QAI). QAI listed in March with a very heavy allocation to fixed income ETFs (QAI replicates several hedge fund strategies using ETFs) so as stocks have gone up a lot QAI has gone up very slightly.

In addition to QAI, IndexIQ has filed for 15 other ETFs of ETFs that will more narrowly isolate specific hedge fund strategies.

In general terms the concept has merit. While I would want to give any sort of fund like this quite a few months to prove itself, it is reasonable to think that most of these funds can deliver some sort of low vol effect that does not correlate to the US equity market. Some will disappoint, though.

What is not a good bet is some sort of exchange traded, retail product going up 500% in year because it shorted the Latvian lat, the Estonian kroon and the Slovenian tolar as we will probably hear about some hedge fund somewhere doing six months from now.

Who knows how these things will be marketed, but I would bet that many people will assume they can get huge returns. The only way I can see that happening would be if equities in general had huge returns one year.

There will be a lot of funds in this space, but hopefully not unrealistic expectations.

Comments

[Daniel Moser:]

QAI is a marketing gimic and nothing more. They are playing to the crowd i.e. individual investors who do not really understand how "good" hedge funds work but they are well aware of the fact that some hedge funds have earned incredible returns. Any fool with a modest education in 10th grade algebra and 1 college finance course that taught optimization can use curve fitting to replicate a hedge fund strategy-which is all these people are doing. The enormous problem with this ETF is that they are replicating returns 1. using historical data and 2. aren't necessarily capturing the appropriate beta/alpha -which implies that going forward they will never statistically perform the way they are supposed to i.e. multi strategy hedge fund-like returns.

For example....could it be that multi strategy hedge funds exhibit a lower volatility and thus lower correlation to equities becuase of their frequent use of put options or stop losses that effectively allow them to create an assymetric payoff profile relative to long only stocks? Whereas QAI is simply using an overweighting to fixed income ETFs to create a very low volatility (they hope postive absolute return) investment vehicle. How are those two things similar?

I have said it before, and I am confident I will be able to prove it when more data is available on QAI, investors who purchase this ETF should not expect returns similar to a multistrategy hedge fund platform. They might make money or they might lose money...but I am extremely confident they will not realize returns that are statistically similar to any multi strategy hedge fund index.

It is a gimic, designed to take advantage of people's desire to get away from long only equity managers. Having said all that, these guys are quite smart for rolling out these vehicles and will without a doubt make a lot of money for themselves via fees and what not. But investors in these particular ETFs are being setup for disappointment. Please be very skeptical of these sort of investment vehicles before you buy them (if you intend to hold them for any lengthy period of time).

If you don't believe me...go online and look up Cliff Asness. He founded and runs a very large hedge fund investment company called AQR Capital Management. In early 2009 he rolled out a passive hedge fund strategy mutual fund. Go online and read about his mutual fund. I believe if you go to this website: www.aqrfunds.com/defau... there are some video interviews in which he discusses these funds and explains how they work. If they aren't there you can find them elsewhere online. Just watch them...and then compare his company/mutual funds to QAI and see if there is anything you find similar about them at all. I am confident after a tiny amount of due dilligence you will realize that QAI is little more than a marketing ploy.

Jun 05 02:16 PM

[onebir:]

"QAI is a marketing gimic and nothing more." But this doesn't mean that all future 'hedge fund replicator' ETFs will be.

At first blush you have to wonder how a low-cost investment vehicle like an ETF might be able to replicate (extremely) high cost hedge funds. What's going to pay for all the rocket science?

Well, it seems at least some of it has been boiled down and mass-marketed already:
seekingalpha.com/artic...

No idea how this all works, but I'd imagine it'd be possible to launch ETF using similar approaches.

Jun 06 10:12 AM

[searcher:]

"Hedge Fund" - "ETF" ... Please. The concepts, if true to their historical actyality, are not compatible in the real world of security regulation.

Jun 06 02:00 PM

[Alex F.:]

Slovenia has been on Euro for two and a half years so you may wanna update your article.

Jun 08 04:29 AM