Special Guest Posting by: Tammer Kamel, Iluka Hedge Fund Consulting

If hedge funds are market wizards, then hedge fund clones are muggles (non-wizards) looking for Hogwarts. Thus far they don’t seem to have found it or the chamber of alpha, but their efforts are nonetheless valuable to investors.

Hedge fund replication is not wizardry at all of course, it is an elegant application of quantitative finance which I find intriguing, albeit for the wrong reasons.  The right ones are, presumably, the prospects of a hedge fund product at a lower cost, with more transparency, more scalability, more liquidity and better risk management.  This is all desirable of course, providing the clone actually achieves my return expectations.  But this is where I have a problem.  My return expectations are incompatible with current replication technology.  The cloning techniques I have thus far encountered aim to emulate what hedge funds actually do as opposed to what they are supposed to do.  This is a consequence of taking the performance of the hedge fund collective as their replication objective.  But the performance of the collective, or equivalently the average hedge fund, is actually not good.  Thus replicating the average hedge fund is no use to me since the average hedge fund is a bad investment.

More…