New Mutual Fund Based On Hedge Fund Replication Techniques

Recently, there have been some interesting financial products being released and/or discussed (see previous posts, here and here). Now IndexUniverse.com is discussing the development of a no-load, open-ended mutual fund that is based on hedge fund replication techniques. The fund offered by IndexIQ, called the IQ Alpha Hedge Strategy Fund, replicates hedge funds returns by purchasing various combinations of individual securities and ETFs, ETNs, and ETVs. The fund does not come cheap since investors in the replication fund will need to pay both the management fees from the replication fund, along with the operating expenses of the underlying securities and exchanged traded products that are used for replication. As of June 4, 2008, the index was comprised of 13 ETFs, ETNs, and ETVs representing exchanged-listed securities, fixed income, currencies, commodities, and real estate assets. This will bring the total expenses of the fund to 1.64% for investor class shares, slightly below the 2% expense ratios often required by traditional hedge funds. The advantage is that unlike traditional hedge funds, replication strategies can save the investors the 20% fee on profits that is also typical for hedge funds.

The IQ Alpha Hedge Index uses algorithms to create six strategies that seek to replicate the risk-adjusted returns of six different hedge fund indexes, including Long/Short Equity (currently -16.67%), Equity Market Neutral (13.33%), Fixed Income Arbitrage (3.33%), Global Macro (33.33%), Emerging Markets (33.33%), and Event Driven (33.33%). Then, optimization techniques and leverage are used to generated alpha by adjusting the weights among these six hedge fund strategies. In addition to adjusting for return, adjustments are also made to provide lower volatility relative to the S&P 500, with a correlation to the S&P 500 that is similar to the correlation between typical hedge funds and the index. The fund, which has been offered for only a short time, currently has an alpha of 7.72%, beta of 0.48%, and correlation of 0.58 versus the S&P 500. More details about the fund can be found in their fund summary sheet. It is also worth mentioning that a number of researchers, investors, and hedge fund managers do not necessarily believe that replication funds are as fantastic as often advertised. A somewhat dated, albeit still interesting and different perspective can be found in a post at the Hedge Fund blog.