Investors seeking hedge fund returns but without the expense associated with them may find comfort in passive hedge fund strategies, according analysts at Merrill Lynch. The idea, they say, is to replicate hedge fund performance either by using liquid assets -- such as stocks, bonds, currencies and commodities -- or “by mechanically executing hedge fund strategies,” such as “using a systematic rules-based methodology instead of active management.” Fringe benefits to this approach, according to Merrill, may include greater liquidity and transparency. The thinking is that with so much money pouring into hedge funds, thanks largely to institutional investors, and with HF managers scrambling to find investments that will produce results worthy of the fees, “it may be increasingly difficult for investors to justify paying hedge fund fees for the performance of the average active manager if passive alternatives are available,” says ML’s Heiko Ebens, head of U.S. equity derivatives research. Ebens notes that this trend is “entirely analogous to developments we have witnessed within their traditional asset classes,” where passive management has grown in popularity. One danger, say the ML analysts, is that “if hedge funds change their investment styles too quickly, replicating portfolios may lag behind.”
