09.12.2011
By Terry Flanagan

Hedge Fund Replication Prevails

Alternative strategies make their mark on passive, index investing.

IndexIQ, a provider of index-based alternative investment solution released the performance numbers of its proprietary family of hedge fund replication and alternative beta indexes this past week.

The hedge fund replication series, the IQ Hedge benchmark indexes, were launched in 2007, and designed as investable benchmarks that replicate the performance characteristics of sophisticated hedge fund strategies. The family consists of beta indexes replicating the following strategies: global macro, long/short equity, event-driven, market neutral, emerging markets, fixed income arbitrage, and a hedge composite index.

IQ Hedge is the first family of investable benchmark indexes covering hedge fund replication.

As of August 31, IndexIQ reported mostly positive returns year to date, with global macro replication leading the way at just over nine percent, and fixed income arbitrage reporting the greatest losses of almost four percent.

“Global Macro is very flexible, generally they are ‘go anywhere’, ‘do anything’ strategies ranging across all asset classes and geographies,” said IndexIQ Chief Executive, Adam Patti, explaining the strengths of the firm’s top replicating index. “These strategies are ideally suited to exploiting market dislocations in times of stress, which we of course have been experiencing for the past three to four months.”

Patti also mentioned that “renewed optimism in emerging markets has provided some of the upside, as have the spreads in valuation between various currencies and fixed income securities around the world.”

Holistically, hedge fund replication has been on the rise in recent years due to more “client education,” which has gotten “investors more comfortable with the concept of hedge fund replication,” according to Patti.

“Investors are increasingly seeking the use of alternative investments to diversify their portfolios” due to increased market volatility. “This interest has materialized in increased AUM and trading volume as well as a significant number of new platforms offering these liquid, transparent and tax efficient strategies to their retail and institutional clients.”

Unlike investing directly into hedge funds, replication indexes are “designed to offer the risk/return characteristics of hedge fund investing without the structural impediments,” noted Patti, highlighting the lack of liquidity, lack of transparency, high fees and tax inefficiency that may be embedded within the hedge fund vehicles themselves.

Patti acknowledges the pitfalls of hedge fund replication, in times with their respective models experience poor returns.

“If hedge funds as a broad group do very poorly, our hedge fund replication strategies may provide a similar performance pattern,” he said, “However our ETFs and mutual funds tend to outperform the hedge fund universe in very volatile markets given the way those strategies dynamically rotate among the various hedge fund strategies they include in their portfolio.”

Such a rotation is favorable in the long-run, as opposed to a static equal weight or asset weighted model, Patti told Markets Media.

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