A New ETF Built On Stocks From Top Hedge Funds

Date: Monday, June 11, 2012
Author: Abram Brown , Forbes

Want to buy like the best hedge fund managers? A new exchange-traded fund, Top Guru Holdings Index (GURU, $15.48), offers a simplified way to become an at-home version of say, Greenlight Capital’s David Einhorn.

Unlike other ETFs using hedge fund-like strategies, Guru sticks to stocks—mostly U.S. equities, with 20% of assets going outside the States. A portfolio of some 50 stocks are selected by screening for hedge funds with more than $500 million in assets; significant allocation to U.S. equities; a top holding that’s at least 5% of total assets and low turnover. “Any fund that’s out to hold for seconds or minutes is irrelevant to our investors, so we filtered those out,” says Bruno del Ama, CEO of Global X Funds (assets: $1.5 billion), which built the ETF.

Each hedge fund’s top holding goes into the portfolio. In effect, Global X built a basket of “high-conviction ideas,” as del Ama puts it, from some of the best living investors. When Global X first constituted the ETF earlier this year, the screen found 68 hedge funds that fit the bill: big names like Paulson & Co. and Pershing Square Capital Management, as well as, yes, Greenlight. Some held the same top holding, so Guru ended up with 51 different stocks to start, and about 2% went into each. The ETF’s top holding is home-loan lender Nationstar Mortgage Holdings. It’s a wide-mix, though, that includes names like Apple, Kraft, JPMorgan Chase and Google too.

The ETF began trading last Tuesday, and finished the week up 2.5%.

Since hedge fund managers must release quarterly Securities and Exchange Commission fillings, as does any institutional money manager with more than $100 million in assets, Global X plans to rebalance Guru after each quarter, running the screen anew using the fresh data. “The fact that you have complete transparency to what John Paulson or what Bill Ackman or Daniel Einhorn, it’s pretty amazing, right?,” says del Ama. “Because of U.S. regulatory requirements you have a huge amount of transparency of the best ideas from the best investors.”

To be sure, it’s not complete transparency. The 13-F fillings require only long positions to be reported, and it’s not as current as you might think. It’s actually a 45-day lag.

Global X faces a crowded field. There are many ETFs hoping to duplicate the success of the hedge fund industry. Many try to mimic specific investing methods, like global macro or fixed-income arbitrage. Guru separates itself from the others through its simplistic and transparent approach to owning hedge fund-favored stocks. Its costs, a 0.75% expense ratio, are in-line with competitors.

ProShares and IndexIQ offer some of the most competing ETFs, like Hedge Replication (HDG, $38.22) and Hedge Multi-Strategy Tracker (QAI, $27.26). What’s more, another ETF devoted strictly to copying hedge funds’ equities holdings launched last week too. However, AlphaClone Alternative Alpha ETF (ALFA, $25.07) offers no insight on its holdings, and tries to take the idea a step further; depending on market volatility, the ETF will split its assets evenly between long and short positions. It’s more expensive than Guru, with a .95% expense ratio.

It’s easy to understand why investors out to become Paulson 2.o are interested. Only accredited investors can buy hedge funds, and many such funds contain illiquid assets. ETFs, of course, are a very liquid investment. Grandpa can buy them through his retail brokerage account. And ETF fees are much less than what a hedge fund manager might charge.

Global X contracted another index provider, Structured Solutions, to run a roughly three-year backtest—from February 2009 to January 2012—using a basket of stocks similar to Guru’s current one. The test found Guru would have returned some 31%, while the S&P 500 returned 22%. Guru also stayed a touch less volatile, too. Del Ama declined to talk about the specifics of the backtest, citing SEC restrictions.

For sure, though, such a return would be a fine start for an Armchair Einhorn.

Reach Abram Brown at abrown@forbes.com. Or follow him @abebrown716.