IndexIQ has recently filed for products to synthetically replicate hedge fund strategies. This is an interesting development for “retail” hedge fund investing. There is a widely held belief that hedge funds earn their returns through identification of market inefficiencies and by superior investment selection, i.e. by producing "alpha". However, the majority of hedge funds generally trade the most efficient markets and an alternative explanation of the hedge fund alpha is that the alpha is actually an alternative beta, i.e. basically an exposure to unavailable-to-retail asset classes, such as size or value-growth bet in the equity markets.

There are two common ways to construct the beta. The first way is the regression approach. Put simply, pick a hedge fund peer-group performance index and carry out a regression with existing asset class and rebalance frequently. This is called "synthetic replication". Replication products made a lot of news in 2007 - but that is not what people really want.The big problem with "synthetic" replication is that the replicated product can deviate substantially from the original.