Search Keywords
Financial Times Wall Street Journal Economist
News Period From   To
News: 60885    Funds: $437    Pays: $524

Go Back to
News List
|
|
This News on
Daily Paywall
  Rated 124 | Views 528
Rate it | Share it 

Markets
Time may be up for hedge fund replicants
From the Financial Times of Mon, 22 Dec 2014 08:43:49 GMT

In the movie Blade Runner, human clones known as Replicants exhibit a powerful survival instinct while their human creators try to hunt them down and “retire” them before they start to malfunction.

In the investment world, replicants are also refusing to go quietly. Products that aim to replicate the performance of hedge funds continue to spring up, despite repeated disappointments and despite the fact that hedge funds themselves are being questioned like never before.

Hedge fund replicants purport to track the hedge fund industry in much the same way as index trackers passively follow the stock market, reducing costs and eliminating the risk of picking the wrong manager. Unlike funds of hedge funds, which can be illiquid, it is easier for investors to pull their money out. Sounds so good, one might imagine replicants were a kind of “Vanguard for hedge funds”.

But behind the simple marketing idea of a “hedge fund index tracker” lies fiendish complexity, imprecision and danger.

Replicants emerged a decade ago amid academic suspicion that hedge fund managers added much less value than they claimed. Most of the industry’s returns seemed to be explained by a handful of factors such as the movement of the equity markets and a few key bond and commodities indexes.

From that research, it was a short step to try to capture those underlying factors using a mixture of derivatives and exchange traded funds, to create purported hedge fund clones.

There are questions, however, over what exactly it is these replicants are supposed to be tracking, and how anyone can know if they are tracking it well.

Indices of hedge fund performance have a well-known bias to the upside, because poorly-performing funds can stop reporting their results and the worst performers shut down all together. In some sub-indices, as many as one in five index members can disappear from one year to the next.

Against a moving target, the tracking error of replicant products has been wide, and almost exclusively to the downside.

Hedge fund managers tend to scoff that their skill comes partly from knowing when to get in and out of positions, creating market timing profits that clones, basing their models on historic data, cannot hope to match.

The replicant creators’ response is to build ever more complex models and shift their investment strategies more often. This has apparently reduced tracking error but at the cost of making these products more of a “black box” that investors without academic backgrounds cannot hope to penetrate.

And there still remains the wider problem of over-fitting, where what appears to be a pattern in the historic data turns out not to be so when it is tested in real time.

Yet replicants are not only surviving but striving anew to win over institutional and retail investors.

IndexIQ, which sells exchange traded funds that it describes as hedge fund replicators, was acquired this month by New York Life, a powerful fund distributor. Goldman Sachs has filed for regulatory approval to launch five hedge fund replication ETFs of its own. And QuantVest Capital said this month that it planned to launch a product that tracks the new Eurekahedge 50 index of elite hedge funds.

The developments come as the marketing pitch of the hedge fund industry itself has evolved. Where the focus was historically on the promise of higher returns, it now focuses on its lack of correlation to other markets, lower volatility and ability to limit losses if equity markets turn sharply down.

This more meagre ambition is not to everyone’s taste. This year, the giant California pension fund Calpers cut its entire allocation to hedge funds, saying the sector was too expensive and too complicated to bother with, given the modest returns.

Replicants think this questioning of hedge funds may be an opportunity for them, since they can pitch themselves as a low-cost, more liquid way for an institutional investor to get the same exposure. More likely, an existential crisis for hedge funds is a crisis for their clones, too.

The best marketing hope for replicants seems to be their promise of uncorrelated returns, the holy grail of investing since the financial crisis, when most traditional asset classes traded in tandem. But while their returns may indeed be uncorrelated, this is perhaps in the ironic sense that they use over-fitted models to imperfectly track a dubiously-calculated benchmark of an industry whose performance has been unpredictable and disappointing.

The latest generation of replicators promises much, but if they do not deliver it will be time to send out a Blade Runner to retire them.

stephen.foley@ft.com



This article is provided by DailyPaywall.com, which is published and distributed by Paolo Cirio Ltd., registered in England, number 8188080. Registered Office: Suite 36, 88-90 Hatton Garden, City of London, EC1 N8PG, United Kingdom. Paolo Cirio Ltd. alone is responsible and liable for information and services provided through Daily Paywall’s newspaper and website.

Truth has a value, and now you can enjoy it!




Earn Money
Offer Money
Buy Advertising
Buy Artwork Article

Similar Articles