Barron’s had an article over the weekend called Attack of the Hedge Fund Clones. The concept has grown in terms of AUM and proliferation of funds. ETF provider IndexIQ was early to market in the ETP space and now there are a lot of funds offering some version of absolute return or hedge fund replication. There have also been plenty of traditional mutual funds that have come into the space.
The article mentioned a new fund called the Frost Diversified Strategies A Fund (FDSFX)—obviously it is a front loaded fund and I was not able to find another fund class on Google Finance. It also offered the paragraph below that I think gives some insight into how the fund will be run:
"Unlike private equity, I can't buy 100 acres of farmland, but I can buy agricultural, commodity-related or industrylike ETFs that have trading histories and represent the desired allocation," he says. In addition to holding up to 10% in cash, his fund plays stocks through exchange-traded index funds, and uses bond index funds, too. He makes liberal use of collars—price ceilings and floors for the securities—a conservative strategy. Stringfellow (the manager) also buys from the rapidly expanding universe of ETFs and notes, and master limited partnerships for exposure to alternative investments.
There are two things to not lose sight of. First, from reading that paragraph it seems like the fund will own funds that anyone can buy for themselves. From that first sentence it appears that someone with a position in the Market Vectors Agribusiness ETF (NYSEARCA:MOO), the Global X Copper Miners ETF (NYSEARCA:COPX) and Enterprise Products Partners Limited Partnership (NYSE:EPD) could be halfway home. Of course I am making a gross overgeneralization, but the fund will apparently be comprised of things easily accessed by anyone in pursuit of replicating a hedge fund. The managers also manage a dividend-focused mutual fund, which has been an outstanding performer; so maybe the new hedge fund clone deserves the benefit of the doubt, but there is nothing wrong with casting a skeptical eye toward a fund like this (the intent is not pick on this one fund but to create awareness in the context of the whole category).
Another point to make is that this particular fund appears to be a "go anywhere" fund (I was not able to find a detailed description at Morningstar, Yahoo or the manager’s website). One goal for the end user buying this type of fund is to take on something of a predictable result for the portfolio. For example if you buy a high yielding utility stock you probably want it to be a low volatility holding that pays its dividend or maybe even increases it every so often. If you buy Apple (NASDAQ:AAPL) you are probably trying to add volatility - the good kind - to your portfolio. The manager of a "go anywhere" hedge fund replicator could at times line up the fund to target a low vol or absolute result or at other times to be a high octane-go for maximum alpha. The timing of either could turn out to be wrong, or not what you as the end user had in mind at the moment, or the timing could be right but the strategy somehow implemented incorrectly or ineffectively.
This contrasts with some of the narrower focus of some of the other hedge fund clones out there. I’ve used these, in moderation, for clients and prefer that the fund target one specific effect. Of course there is no guarantee of always delivering that effect but it makes for fewer variables in the fund and by extension in the portfolio.
Disclosure: I am long MOO.