With hedge funds back in the black, how are the hedge fund “clones” doing?
Jun 1st, 2009 | Filed under: Alternative Beta & Hedge Fund Replication, Today's Post
With hedge fund performance starting to look up, a reader recently suggested we check up on the trials and tribulations of “hedge fund replicators” - those who aim to clone the returns of hedge funds via passive exposure to highly liquid and ubiquitous investments. The most well understood method of doing is to use a factor model based on a trailing regression of hedge fund industry returns. One of the most prominent players in this space is probably Merrill Lynch, purveyors of the “Merrill Lynch Factor Model” (factor model website).
The firm describes the index this way in its marketing sheet:
“The Merrill Lynch Factor Model (the “Model”) is designed to provide a high correlation to “hedge fund beta,” the portion of hedge fund returns which can be explained by exposure to certain market measures, and not individual manager skill. To accomplish this, the Model seeks to emulate the performance of the HFRI Fund Weighted Composite Index (the “HFRI Composite Index”) using the publicly reported prices of a basket of liquid, well-known market measures. The HFRI Composite Index is a non-investable index which tracks the performance of over 2,000 hedge funds on a monthly basis.”
So how has it done at “emulating” the HFRI? According to Merrill’s data, pretty well. Although its marketing sheet hasn’t been updated since the end of 2007, raw data provided on the product’s website shows the Factor Model and the HFRI Composite have a rolling 24 month r-squared of about 0.9 over the past several years. More…




In just about every action movie and TV show these days there is at least one scene where the hero asks one of his or her techies to “sharpen” a satellite image. Suddenly, what looked like a fuzzy bunch of pixelated squares takes on the form of someone’s face, a car, or some kind of mobile rocket launcher. We’re not graphic imaging specialists. But to us, it looks kind of outlandish that someone could take a very small amount of information (a few pixels) and divine the underlying image in fantastic detail.
Passive investment in hedge funds has always been somewhat of an oxymoron. Hedge funds, after all, aim to deliver active management (alpha). And since alpha is a zero sum game, a passive investment in hedge funds should deliver a zero return. Nonetheless, this axiom has always been challenged by proponents of various products designed to deliver aggregate “hedge fund returns”.
Looks who’s making a return trip to the news after being largely tossed away by the media last year. It’s alternative beta and 130/30. As regular readers will recall, these hedge fund relatives seems to have died off 

