How Do Hedge Fund Clones Manage the Real World?

Abstract

Several hedge fund replication products have been launched in recent years. Prior to the financial crisis these products were a much discussed topic among academics and practitioners alike. Since the financial crisis however, the interest in replication products has somewhat dissipated. Replication products generally follow three approaches: reverse engineering, factor-based, or distribution-based. This article analyzes the performance of several replication products that are offered by various asset management companies. The results show that the return distributions are heterogeneous among the set of replication products. The results also show high correlations with small-cap equity, large-cap equity, and international equity across most replication products. However the monthly tracking error was often high. The authors conclude that replication products such as hedge funds fall short on delivering absolute returns. Furthermore, the replication products are unable to capture attractive risk-return features of hedge funds. Investors should thoroughly evaluate replication models to determine their suitability in institutional portfolios. <b>TOPICS:</b>Real assets/alternative investments/private equity, factor-based models, performance measurement