For nearly a year now, the hedge fund industry has been poked and prodded by ”hedge fund replicators”.  Wave after wave of academic research seemed to show that hedge funds weren’t that special after all.  When it looked like factor modeling might face some limitations, a new technique known as “distributional replication” was heralded by some as the proverbial nail in the coffin of the hedge fund industry.

The truth about hedge fund replication likely lies somewhere between the mythical “pure alpha” hedge fund manager and the black box hedge fund “clone”.  But, sometimes the hedge fund industry seemed to be caught off-balance by the replicators - unable to produce the “counter-research” that cogently makes their side of the argument (perhaps because the industry was doing just fine and had no economic reason to respond).

Now one company has released a comprehensive analysis of both replication techniques (factor modeling and distributional replication).  Toronto-based fund of funds manager Northwater Capital Management has just completed a rather extensive report that may give the hedge fund industry what it’s looking for – quantitative research giving another side of the replication story.  Northwater’s thesis is that both underlying approaches to hedge fund replication are “limited in their ability to access the performance of hedge funds”.

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