Hedge Fund Indexation And Replication

October 23, 2013

 

References
Amin, G. and Kat, H. "Hedge Fund Performance 1990-2000: Do the Money Machines Really Add Value?", Journal of Financial and Quantitative Analysis, vol. 38, no. 2, June 2003, pp. 1-24.

Asness, C., Krail, R. and Liew, J. "Do Hedge Funds Hedge?", Journal of Portfolio Management, no. 28, Fall 2001, pp. 6-19.

Fung, William and Hsieh, David. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, vol. 10, No. 2, 1997. pp. 275-302.

_____, "Performance Characteristics of Hedge Funds and Commodity Funds: Natural and Spurious Biases," Journal of Financial and Quantitative Analysis, vol. 35, No. 3, 2000, pp. 291-307.

_____, "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, vol. 14, No. 2, 2001, pp. 313-341.
_____, "Asset-Based Style Factors for Hedge Funds," Financial Analysts Journal, vol. 58, No. 5, 2002, pp. 16-27.

_____, "Hedge Fund Benchmarks: A Risk-Based Approach," Financial Analysts Journal, vol. 60, No. 5, 2004, pp. 65-80.

Geczy, Christopher C. "Thoughts on the Future of the Hedge Fund Industry," The Wharton School, University of Pennsylvania Working Paper, April 2010.

Kat, Harry M. and Palaro, Helder P. "Hedge Fund Returns: You Can Make Them Yourself!", Cass Business School Research Paper, AIRC Working Paper No. 23, June 8, 2005.

_____, "Who Needs Hedge Funds? A Copula-Based Approach to Hedge Fund Return Replication," Cass Business School Research Paper, AIRC Working Paper No. 27, Nov. 23, 2005.

Lo, Andrew and Hasanhodzic, Jasmina. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, V.5, No.2, 2007, pp. 5-45.

Sharpe, William, F. "Asset Allocation: Management Style and Performance Measurement," Journal of Portfolio Management, vol. 18, 1992, pp. 7-19.


Endnotes
1 Andrew Lo of MIT is also the founder of hedge fund replicator AlphaSimplex, now a part of Natixis. Thomas Schneeweis, of the University of Massachusetts, is the founder of hedge fund replicator S Capital.
2 Also called "rule based" or "trade related."
3 Professor Harry Kat of the Cass Business School in London is the primary proponent of this approach. The references at the end of this paper contain multiple citations of his work on this topic.
4 Geczy [2010] uses this terminology.
5 The first four moments of a statistical distribution are its mean, standard deviation, skewness and kurtosis.
6 Geczy [2010], pg. 3.
7 ibid. pg. 6.
8 A short position in a replication product could act like a slightly out-of-the-money put option. The option analogy could produce demand for these products from investors not currently investing in hedge funds.
9 "Monitors" refers to risk managers, accountants, auditors and regulators.
10 This section focuses on factor-based replication because it is the most common methodology used by the current universe of commercial replication products. These answers are generally applicable to mechanical replication as well, but are inadequate as a basis for analyzing the distributional approach.
11 The section titled "How Does Hedge Fund Replication Work?" explains how a linear regression of a hedge fund index against a set of economic variables allocates the index returns to random and nonrandom components while further dividing the nonrandom component into correlated ("beta") and uncorrelated ("alpha") parts.
12 A Sharpe ratio is a measure that indicates the average return minus the risk-free rate of return divided by the standard deviation of return on an investment.
13 The monitoring services that funds of hedge funds perform address transparency and business-risk issues, and aim to align investors' portfolios with their liquidity preferences, thus managing actively the three transactional issues that replication addresses passively.
14Index performance represents past performance and is no guarantee of future results. Index performance does not reflect the deduction of any fees or charges that would lower performance. An investor cannot invest in an index.
15 Source: Hedge Fund Research. Appendix B lists the indexes and the data shown in Figure 4.
16 Source: Bloomberg. Appendix A lists the replication indexes and funds shown in Figure 4.
17 Source: Hedge Fund Research. Appendix C lists the indexes and the data shown in Figure 4.
18 Index performance represents past performance and is no guarantee of future results. Index performance does not reflect the deduction of any fees or charges that would lower performance. An investor cannot invest in an index.
19 ibid.
20 ibid.

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