Hedge fund clones get mixed reviews

Date: Monday, November 24, 2008
Author: Steve Johnson, FT.com

Some 15 per cent of asset management houses, pension funds and private banks have invested in hedge fund replication strategies, according to a survey by Edhec, the French business school.

A further 55 per cent of institutions said they were willing to consider investing, with 30 per cent saying they never would.

Replication strategies aim to artificially recreate the net exposures, and therefore returns, of the hedge fund industry without the costs and drawbacks of investment in the underlying funds themselves.

A series of banks, including Goldman Sachs, Merrill Lynch and Credit Suisse, have launched replication products in the past two years, joining Partners Group, a Swiss alternative outfit that pioneered the strategy in 2004.

Respondents to Edhec’s survey lauded the low charges of the clones – which typically charge a flat fee of around 1 per cent, compared to the “2 and 20” model of the underlying industry – and their high liquidity, sidestepping the often lengthy lock-up periods imposed by many funds.

However, a significant minority of the 97 respondents believed hedge fund returns were not replicable, with similar numbers arguing cloning strategies lacked transparency, were based on unproven technology or performed poorly. “We conclude that many investors are likely to wait for the development of better products,” said Edhec. “For the time being, they prefer actual hedge funds or other substitutes for hedge funds to passive replication products.”

A study by Edhec in 2007 concluded that although it may ultimately be possible to create hedge fund clones, banks had launched commercial products before the academic research had come up with workable solutions.