Hedge Fund ETFs Just As Bad As Hedge Funds

There's hasn't been much good news in the world of hedge funds recently. Performance has been lousy and investors are heading for the hills. As a Bloomberg article this week points out, outflows from hedge funds were $15 billion in the first quarter, the largest since 2009.

Understandably, investors have been disappointed by the returns in hedge funds. Far from offering the alpha that investors desire, these funds have struggled just to keep up with vanilla stock indexes like the S&P 500.

In the year-to-date period through April 19, the HFRX Global Hedge Fund Index lost 1.3%, compared with a 3.5% gain for the S&P 500. That follows seven-straight years of underperformance between 2009 and 2015.

ETF Assets Top Hedge Funds

With performance so abysmal, it's no wonder investors may be reassessing the asset class. Total hedge fund assets now amount to $2.86 trillion globally, according to Hedge Fund Research Inc., below the $3 trillion worth of assets in ETFs.

Of course, the bulk of the money allocated to exchange-traded funds is aimed at passive investments ― the antithesis of hedge funds. Those include the $187 billion SPDR S&P 500 ETF (SPY | A-98) and the $35 billion iShares Core U.S. Aggregate Bond ETF (AGG | A-98).

It's fair to say that the majority of investors in ETFs shun the alpha-seeking strategies of hedge funds. But not all of them.

There's a small, but growing, amount of money in ETFs tied to active strategies, with hedge fund strategies among them.

Different Wrapper, Same Underperformance

On the plus side, thanks to the ETF wrapper, these strategies are widely available to investors of all stripes at relatively low costs. That's in contrast to actual hedge funds, which are typically only open to accredited investors and have high costs associated with them.

That said, these hedge-fundlike ETFs haven't performed much better than hedge funds themselves.

The largest of these ETFs is the IQ Hedge Multi-Strategy Tracker ETF (QAI | C-73), which has $1.1 billion in assets. QAI uses several hedge fund investment styles to emulate the returns of a multistrategy fund of funds. These include long/short equity, global macro, market neutral, event driven, fixed-income arbitrage and emerging markets.

Currently, QAI has a heavy allocation to fixed income. Its top six holdings are all fixed-income ETFs, representing 57% of the portfolio. A year ago, QAI'S portfolio was quite different, and held a 41% position in a single fund, the iShares MSCI All Country Asia ex Japan ETF (AAXJ | B-93).

In terms of returns, QAI has done a bit better than the aforementioned HFRX Global Hedge Fund Index this year, but it's still lagging the S&P 500. The ETF is up 2.2% so far in 2016, slightly below the S&P 500's 3.4% return.

YTD Returns For SPY, HFRX Global Hedge Fund Index, QAI

Longer term, it's shown the same pattern of consistent underperformance as other hedge funds. The ETF has yet to beat the broad stock market in any year, and is up only 24.9% since its inception in March, 2009. That compares with 12.4% for the HFRX Index and 197.6% for the S&P 500.

Copycat Hedge Fund ETFs Also Lag

Another popular hedge fund ETF is the Global X Guru ETF (GURU | B-54), which has $125 million in assets. Rather than replicate hedge fund strategies internally, the fund simply piggybacks on the stock picks of large hedge funds based on their public filings.

If these hedge funds―many of which are run by high-paid "star" portfolio managers―do well, GURU should do well also (the downside is that GURU looks at lagged 13F filings to see hedge fund positions, which puts it behind the curve when it comes to some of the trades the hedge funds are making).

Unfortunately, like hedge funds in general, GURU has fared poorly. Year-to-date, it's down 3.3%. A rival fund, the AlphaClone Alternative Alpha ETF (ALFA | C-26), has done even worse, losing 9.1%.

YTD Returns For SPY, GURU, ALFA

The pair had a great year in 2013, outperforming the S&P 500's return, but they've been unable to emulate that success since then, as the stock market has gotten choppier.

Since inception in mid-2012, the ETFs are now lagging the broad market, with returns of 59% for GURU, 41.7% for ALFA, and 76.8% for the S&P 500.

Contact Sumit Roy at [email protected].