Attack Of The Clones May Harm Hedge Funds

Dow Jones Indexes last week played down reports that it was considering the launch of an investable tracker that will mimic hedge funds. DJ says there is nothing serious yet, but if it does come to pass it may find it is a Jonesy come lately, as there are academics ready, willing and they say able to peel away that which makes hedge fund investment appear special. Financial Times reports that at least two rather big name academicians are looking to capitalize on their own HF replication strategies. Professor Andrew Lo of the Massachusetts Institute of Technology is said to be preparing to launch a product of his hedge fund-like strategy early next year, and Professor Harry Kat of London-based Cass Business School is reportedly having a couple of family offices already test drive his clone product. Lo’s high purpose, according to FT, is "to threaten existing hedge funds that disguise beta as alpha. It will be harder for them to justify their existence" by raising the bar for hedge funds. FT suggests that this aping trend is just to prove that "much of the magic of hedge fund performance is little more than sleight of hand." Take that away, says the paper, and it becomes clear that returns have "often more to do with movements of underlying markets than the skill of the manager." Some strategies, such as fixed income convertible bonds, long/short equity and managed futures appear to depend more on "systematic exposure to ‘alternative beta’ risk factors," says FT. Which means that the skillful hedgie can still outsmart the clones. Lo told FT that he uses "futures, forwards and other liquid financial instruments" to get those risk factors to which HFs are exposed, but seems to admit that it won’t work on all strategies. The end result of replication, he says, will be lower fees, better transparency and greater capacity in the HF sector. For his part, Kat says he believes he can replicate 83% of some 2,000 hedge funds he studied; the balance, he said, thrive on the talent and "tricks" in the manager’s bag. Whether they’ll succeed remains to be seen, but replication could have a "dramatic impact" on the industry," says Lar Jaeger of Partners Group in an FT interview. "This is going to turn the industry upside down."