Arthur: A True Hedge Fund In An ETF

January 15, 2014

QEH is a core hedged equity allocation, as it incorporates multiple hedged equity styles. The universe of managers that QEH tracks consists of roughly 1,000 managers, while all are hedged equity, of varying styles and strategies.

Examples include: market neutral, U.S., non-U.S., U.S. large-cap, U.S. small-cap, Asia, Western Europe, Eastern Europe, Latin America, health care, technology, energy, etc.

Using the core approach with an ETF like QEH minimizes the desire to chase the "hot dot" money manager, and the possibility of buying them near the end of a good run.

To be perfectly honest, I can think of six reasons QEH is a sensible way to achieve core hedge fund exposure. They are:

  1. Long-term risk-adjusted returns of hedge equity are very attractive compared with long-only managers.
  2. Individual manager selection is very difficult (professionally managed fund of funds can't beat the unmanaged indices). See Figure 1.
  3. Downside protection has been consistent. While hedged equity has only beaten the S&P 500 Index 50 percent of the time on a calendar-year basis, hedged equity has experienced half of the calendar year downside, on average, during the last 24 years (-5 percent versus -10 percent) and has bettered the index in 21 out of the 24 years.
  4. Smart beta and dynamic nature of the QEH portfolio. QEH adjusts its exposures as the portfolio managers' analysis sees the equity hedge universe of managers (approximately 1,000 firms in total) adjusting their exposures. The adjusted exposures are:
    1. Overall net exposure (will typically fall between 40 and 70 percent)
    2. Geographic (region and country specific)
    3. Economic sector exposure (current overweights are to financials, information tech and health care; underweights to telecom and consumer staples).
  1. Market cap (large, mid, small)
  2. Value/growth
  3. QEH is a global portfolio. While it varies, QEH typically has up to one-third of its net exposure outside of North America, including not only developed economies but also emerging and frontier markets.
  4. Hedged equity performs well in rising-rate environments. While hedged equity may experience short-term pullbacks, over a multimonth rate move, hedged equity has made money during the six rising-rate periods since 1990 (see "Seeking Alpha: Long/Short Equity in Rising Rate Environments," Sept. 30, 2013 and Figure 3).


HFRI Eq Hdg Ind and S&P 500 Ind Ann Rtns


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