Alternative Routes to Hedge Fund Return Replication
With the growth in the hedge fund industry has come a decline in the value added by hedge fund managers. Given the high fees typically charged by hedge funds, some have questioned whether passive approaches can be constructed that would provide returns similar to those of hedge funds while offering greater transparency and liquidity.
In the Winter 2007 Journal of Wealth Management Harry Kat discusses three general approaches to hedge fund replication:
- Factor Models
- Mechanical Trading Rules
- The author’s FundCreator product
In a factor model, linear regressions determine the market exposures experienced by a hedge fund or hedge fund index. Factors may include stock, bond, commodity and currency returns, or changes in credit spreads and market volatility. These exposures can then be taken via index products or derivative instruments.
In the case of funds that add value by timing short-term changes in market exposure, the investor’s trading behavior can be compared to mechanical trading rules.
The FundCreator product is a risk management tool that allows the investor to target the risk and correlation properties desired in order to maximize diversification potential.
For more information, see all articles on: Active Management, Alternative Assets, Asset Allocation, Hedge Funds, Institutional Investing, Investment Returns, Passive Management, Research, Risk Management See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
