How to make a hedge fund
Hedge fund managers have long held a reputation for being smarter than the average investor.
But replicating their returns may not be as difficult as you think, according to S&P Dow Jones Indices.
Tim Edwards, senior director of index investment at the firm, says he has built a simple model that combines stocks and bonds and which replicates the average performance of hedge funds.
His claim comes after news this week that assets in exchange-traded funds – ultra-low cost, passive funds that track markets – have now exceeded assets in hedge funds – which cost far more but which offer access to a fund manager’s supposedly superior skill.
Assets in the 5,823 ETFs and other exchange-traded products listed globally total $2.971 trillion, according to consultancy ETFGI LLP. Assets in hedge funds world-wide total $2.969 trillion, according to data group Hedge Fund Research.
Mr. Edwards said his simple replication
strategy invested half in U.S. bonds, via the S&P U.S. Aggregate Bond index, and half in stocks, via the S&P Global 1200 index.
If the fund is rebalanced every month, and after allowing for a management fee of 1.5% a year and a performance fee of 15%, then its performance starts to look pretty similar to the HFRI Fund Weighted Composite Index of hedge fund performance. Even monthly swings in performance both up and down are mirrored in the replicator.
Investors are still putting money into hedge funds at a fair pace – funds attracted almost $40 billion in new cash in the first half of this year. But, after constructing his model portfolio, Mr. Edwards had a damning verdict.
“The average hedge fund looks like a fixed blend of cheap investments, at high cost,” he said.
Here’s how the replicated fund stacks up against the HFRI Fund Weighted Composite Index: