New Deutsche Bank hedge fund replication offering gets both laurels and darts
May 28th, 2007 | Filed under: Alternative Beta & Hedge Fund Replication
Last week, Deutsche Bank joined the hedge fund replication party with its new “DB Absolute Return Beta Index“. While it is still too early to gauge the success of the offering, the company’s press release contains some hints about the way it will be spinning this latest entry in an increasingly crowded field.
The early spin deserves both laurels and darts. Deutsche Bank deserves kudos for addressing a common concern about hedge fund replication offerings - that they only attempt to replicate hedge fund returns after fees. There are those who feel that this might be okay if those suppliers didn’t also attack hedge funds for charging too much. After a landmark event on hedge fund replication in London last winter, one reader wrote us to express several concerns. One of those concerns read as follows:
“Just what is being replicated? My understanding…is that (hedge fund replicators) are modeling HF returns net of fees. The utility to the end investor will be the same as if they were paying large fees to a hedge fund manager. The saving on fees does not lead to higher returns to the investor. This has been conveniently overlooked.”
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[…] All About Alpha on why it makes more sense to attempt to replicate broad hedge fund indices versus more narrowly defined return streams. […]
An anonymous reader writes…
“A point you might want to consider re anybody who claims to be replicating hedge fund returns BEFORE fees is that you can’t simply add back a fixed percentage to the published returns (even if you knew what the ‘right’ percentage of fees was across the many different fee structures which sit within an index). High water marks and hurdle rate arrangements (which of course also vary significantly across funds in the index) mean that any regression analysis has to deal with the fact that the factor coefficients are time varying.
“Simply taking off an average is going to smooth the ‘fees’ and effectively remove the high water mark provision. A high water mark is a very big incentive for a manager not to take big hits as it can mean many months surviving on management fees alone - not a happy prospect when you have large fixed monthly costs.
“I suggest you ask DB what their ‘methodology’ is for re-creating the before fee returns.”
These hedge fund replication products are just a crazy emperor-has-no-clothes gambit. Anyone familiar with linear algebra should be able to see through them, as explained here: http://federalist.wordpress.com/2007/06/01/hedge-fund-replication-nuts/