Two exchange-traded funds that mimic hedge fund equity strategies have just passed their one-year anniversaries. The bad news for hedge fund managers is that both of these funds, the AlphaClone Alternative Alpha ETF and the Global X Top Guru Holdings ETF, performed as well as or better than the funds they emulate.
Granted, the so-called clones have a few advantages in a bull market. But if the managers of these two ETFs continue to pick their stocks well, they might at least have a formula for beating the markets in a downturn. Not every hedge fund can say that.
Mutual funds and ETFs that follow and then copy hedge funds have proliferated in the last few years, taking advantage of disclosure laws to find out what hedge funds are buying and holding. Market observers have questioned their ability to deliver consistent returns at low risk. Andrew Lo, the Massachusetts Institute of Technology finance professor whose research on achieving alpha was one of the main forces behind the growth of hedge fund clones — and who launched his own clone fund, Natixis ASG Global Alternatives, in September 2009 — says roughly half of hedge fund returns can be explained by broad market exposures. That leaves another half that comes from portfolio manager expertise. And the strategies available to clones are no-frills, generally limited to long positions in publicly listed securities.
What both AlphaClone and Guru do is identify and buy the top equity holdings of large hedge funds, information readily available through Form 13F, the document U.S. based hedge fund managers with $100 million or more in assets must file quarterly with the Securities and Exchange Commission to show all of their long positions in publicly-listed securities. That information has some obvious shortcomings, since hedge fund managers can wait as long as 45 days past the last day of the quarter to file their 13Fs — and many do just that. But the managers of both clone funds look for high conviction on the part of the hedge fund managers, buying only the stocks that appear as top holdings quarter after quarter.
“Why doesn’t time lag hurt our performance more? There are a couple of reasons,” says Maz Jadallah, CEO and portfolio manager at AlphaClone in San Francisco. “For one thing, the holding periods are a lot longer than most people think. We mostly look for fundamental bottom-up managers, and their average holding period is a year or longer for high conviction positions. Also, on average most of the alpha comes from long positions, not from shorting.”
One advantage for both clones in a bull market is their small size compared with the hedge funds they track. AlphaClone has only $15 million in assets, while Guru has about $50 million. Because they are small, their equity positions loom much larger in their performance than they do for the hedge funds. In a serious bear market the weight of their holdings could push performance way down. Jadallah, however, has developed a risk management tool for downturns that he calls dynamic hedging. The fund managers constantly monitor the 200-day moving average for the S&P 500. If the S&P falls below the moving average they sell 50 percent of the portfolio and put the proceeds into the ProShares Short S&P500, an ETF that seeks to produce daily results that are the direct inverse of the S&P 500.
AlphaClone, which began trading on May 31, 2012, returned 21.3 percent as of December 31, 2012. Year to date through May it is up 16.8 percent. Its performance for its first full 12 months is 36.8 percent, according to figures supplied by the firm. The ETF’s top holdings include American International Group, Apple, News Corp., Mastercard, Simon Property Group and Charter Communications.
While AlphaClone does not disclose the hedge funds it follows (about 400 of them), Global X Guru does. Guru tracks a list of some 60 funds that includes such big names as Appaloosa Management, Avenue Capital Group, Baupost Group, Canyon Capital, Coatue Management, Greenlight Capital, Jana Partners, Omega Advisors, Passport Capital, Paulson & Co., Pershing Square Capital Management, Pine River Capital Management, Third Point and York Capital Management.
Guru, which launched June 4 of last year, rose just over 20 percent year-to-date through mid-June and 43.47 percent in the past 12 months. Many of the hedge funds on Guru’s list have performed reasonably well since last year, although not all did as well as the clones. The multistrategy Canyon Balanced Fund rose 20.4 percent in 2012 and 12.76 percent year to date through May. The Jana Partners event driven fund was up 23.16 percent in 2012 and 11.7 percent year to date through May. The multistrategy Pine River Fund was up 21.7 percent in 2012 and 8.94 percent year to date through May. (Figures are from Hedge Fund Intelligence.)
On average, though, equity hedge funds rose only 6.13 percent last year and 5.65 percent year-to-date through April, according to the Hedge Fund Intelligence Equity Index. For fees of less than 1 percent, investors could have used ETF clones to harness the equity holdings of those hedge fund managers who are presumably the smartest guys in the stock market.
