IndexIQ is seeking to “democratize” hedge fund strategies by providing index-based alternative investments via ETFs, mutual funds, and separately-managed accounts. Its core philosophy is to make hedge fund investment strategies available to all investors via liquid and transparent products.

“Our ETF-based replication strategies seek improved transparency, liquidity, no manager selection risk and other benefits relative to traditional hedge fund products,” Adam Patti, CEO of IndexIQ, told Markets Media. “These help fill a gap in the industry, offering investors access to lower cost, non-correlated investment solutions that eliminate the structural problems associated with the hedge fund industry in recent years.”

Using liquid exchange-traded funds as the underlying investment components, IndexIQ offers hedge fund replication products that covers a range of hedge fund investment styles.

IndexIQ’s IQ Alpha Hedge Strategy Fund uses a proprietary investment process to synthesize the risk and return profiles of a broad range of hedge fund investing strategies, the company says, striving to deliver hedge fund-like performance in a low cost, transparent, and highly liquid investment vehicle.

“When we started in 2006, nobody cared about alternative investments in the retail space,” said Patti. “It was really an institutional phenomenon, which is why we started the company.”

Today, in the post-Madoff, post-financial crisis era, alternatives now are top of mind for advisors. “That’s been a really beneficial thing for our business,” said Patti. “I think it’s a very beneficial thing for investors who finally have the types of strategies to protect their downside risk, just like institutions have been using for years.”

Some advisors have become very sophisticated in the use of alternative, and these are the types of advisors IndexIQ focuses on. “If the advisor doesn’t know what a hedge fund does or doesn’t understand what hedge funds are designed to provide, it’s a tougher conversation,” said Patti. “More and more advisors have become educated over the last few years on how to use different hedge fund styles and really what they can expect.”

Hedge fund replication provides the risk return profile of investing in hedge funds but without all the structural impediments of the hedge funds themselves.

“In the ’90s the academics did a lot of work on what hedge funds provide, what are investors getting for their “2 and 20” fees,” Patti said. “What they found is that there is not as much alpha in hedge funds as you’d expect.”

Because of the maturity of the asset management industry, there’s only a finite number of alpha opportunities in the market. “It’s harder and harder for asset managers to generate alpha,” Patti said. “You see that in the mutual fund space where 85% of asset managers underperform their benchmark. The academics showed that there is not as much alpha and when there is alpha, it’s not persistent.”

On the flip side, hedge funds generally provide a very important characteristic to a portfolio, which they call alternative beta. “What that does is really diversify your portfolio, provide downside protection, and upside potential when the markets go up,” said Patti. “But do you need to pay “2 and 20” fees for this type of performance? The answer is no because if you can identify the asset class exposure the hedge funds are using, you can substitute liquid proxies for those asset classes and package that in a much more liquid, much cheaper package for investors.”

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