It’s hardly surprising, perhaps, that synthetic hedge fund clones are putting an increasing amount of pressure on the “real” hedge fund industry and on the fees it charges. But a recent paper on the nascent, but already highly-lucrative, industry of hedge fund replication — entitled “How do hedge fund clones manage the real world?” — puts it all in stark relief.
In their analysis, posted on the CAIA Association website, authors Nils Tuchschmid, Erik Wallerstein and Sassan Zaker of Julius Baer Asset Management suggest the clones are broadly succeeding in replicating the investment returns of real hedge funds. At the same time, however, some clones have exhibited too much correlation with equity markets and also have raised fears among some investors about the increasing complexity of replication models, the researchers warned.
The report, which looked at 21 clones over the period April 2008 to May 2009, concluded: “Hedge fund replication products seem to deliver competitive performance relative to hedge funds. More importantly they are able to deliver this at a far lower fee level than hedge funds.”
As the FT reports on Monday, a swathe of hedge fund replication products have been launched by banks such as Goldman Sachs, JPMorgan, Barclays Capital and Bank of America Merrill Lynch since 2006.
They are designed to replicate the underlying exposures, and therefore performance, of the hedge fund industry at a fraction of the typical “2 and 20″ hedge fund fee structure (2 per cent of assets and 20 per cent of returns). Clones typically charge a flat fee of 1-2 per cent of assets.
Wallerstein, one of the authors of the paper, believes that strategies such as long/short equity and some fixed income-based approaches are easiest for the clones to replicate, notes the FT. If the clones get enough attention and assets under management, he warned, they will exert some fee pressure on hedge funds. “Then it will be difficult for hedge funds that do very similar things,” he said.
The authors’ research found that the vast majority of clones exhibited a correlation of at least 70 per cent to industry benchmarks operated by Hedge Fund Research and Credit Suisse/Tremont. Most lost less than the typical 10-15 per cent declines recorded by the industry at large, although Wallerstein cautioned, the relative performance of clones in a bull market remained unproven. “Shortable” clones, which allow investors to benefit from losses in the underlying industry, appear to succeed in mirroring long approaches, he added.
“Real” hedge funds might draw some comfort from the report’s suggestion that clones have yet to gain widespread backing from investors, with total assets potentially as low as $2bn. In addition, their very liquidity could be a problem, with some replicators receiving redemption requests for as much as 80 per cent of their assets last autumn — largely because they offered better liquidity than underlying hedge funds.
But in another worry for “real” hedge funds, even banks are getting in on the replication act. Credit Suisse led the way with its move earlier this year to set up a hedge fund clone, teaming up with three of the top academics in the field to create a suite of products designed to replicate mechanically the returns of the major hedge fund strategies.
Related links:
Hedge fund clones grow in appeal – FT
Imitation alpha – FT Alphaville
Recent performance of HF clones – AllAboutAlpha