Hedge funds are hot, but the asset class is notoriously difficult for individual investors to access. Funds of funds are one option for diversified exposure, but Rydex says it has taken the next step with a fund benchmarked to the S&P Hedge Fund Index, which has approximately $2.3 billion of assets tracking it, according to S&P.
Hedge fund indexes are now available from S&P, MSCI, FTSE, Hedge Fund Research (HFR), and CSFB to name a few. Underscoring the complexity of the hedge fund universe, competing indexes often post different returns and volatility because of the way they sample and measure hedge funds. Not all hedge fund indexes are investable.
Summary of Hedge Fund Indexes
For a comprehensive survey of the available hedge fund indexes, please read Mark Anson's article from the Q3, 2003 issue of the Journal of Indexes. (free registration required to access the article).
In addition to the MSCI Hedge Fund Indexes and database listed in the above table, MSCI like S&P has an investable hedge fund index. In May MSCI announced the index exceeded $2 billion in tracking assets, doubling in size from the previous two months. In May the MSCI Hedge Invest Index had 88 funds.
Although the investable indexes are surely benefiting from the public's infatuation with hedge funds, they are controversial. Some analysts and investors wonder if it's possible to even create a representative sample in the murky world of hedge funds.
Another important issue for the indexes in a tight-lipped hedge fund world is achieving the necessary level of transparency. Some index providers gather the underlying data themselves, while others allow the hedge fund managers to enter the data. S&P says its policy of managing separate accounts investing in the underlying hedge funds.
"One of the biggest concerns is ensuring that you have the right access and transparency, through a managed account, to ensure style purity," said Justin Dew, senior hedge fund specialist at S&P. "However, as time goes on, it's becoming a smaller challenge. In the past few months, institutional-quality [hedge fund] managers have become more open to providing transparency, probably because of asset flows into hedge fund indexes."
Rydex likes the transparency the S&P separate accounts provide.
"A portfolio of [index provider] separate accounts is the real value of hedge fund indexes," said Jeff Joseph, managing director of Rydex Capital Partners, the alternative investments division of Rydex Investments (www.rydexfunds.com). "If you don't have separate accounts, then how can you manage risk [as a fund of funds manager]? Separate accounts give you daily position-level detail on all of the underlying managers. Otherwise you're relying a monthly investor letter, or weekly or monthly transparency."
Aside from a lack of portfolio and asset transparency, it is difficult to create a representative yardstick in a hedge fund industry where there are countless strategies constantly being evolved and tweaked.
S&P has addressed the challenge by creating subindexes for different strategies, and by equal-weighting constituents.
"Each of the nine different strategies [Equity Market Neutral, Fixed Income Arbitrage, Convertible Arbitrage, Merger Arbitrage, Distressed, Special Situations, Equity Long/Short, Managed Futures and Macro] are weighted equally," said Dew. "Within each strategy each fund is also weighted equally. However, there are different numbers of funds within each substrategy index."
The S&P hedge fund index is rebalanced annually. The equal weighting was selected for several reasons, said Dew.
"First, hedge fund asset flows are notoriously difficult to ascertain," said Dew. "Also, there are several disadvantages to asset-weighting, because investors would always end up buying hot strategies and reducing their exposure to out of favor strategies. In other words, they would buy high and sell low."