Mar

31

 I believe hedge fund strategies will be new frontiers in the ETF market. As we are seeing ETFs move into more active strategies, we have already seen the beginning of this trend. The quantitative backdrop for evolution can be found in these articles by hedge fund Bridgewater, on selling beta as alfa and levering betas.

My prediction is that the increased accessibility will make it harder to prosper for hedge funds that are currently selling beta as alpha. In effect I see no reason why it couldn't soon be as easy to access some of these strategies as it is to trade the QQQQ today.

Gordon Haave writes:

Yes, but the whole point of the ability to replicate these funds is that you don't need the lockup, or at least not as much of one. One can short volatility without a 1-year lockup.

From Bill Rafter:

The largest portion of hedge fund money is employed in long-short. Long-short is highly liquid and highly scalable, and could easily endure a zero-day lockup. For example, we have a long-only (in theory, less liquid that long-short) large-cap program that has a zero-day lockup. One might ask why. Our answer is "marketing." Investors (particularly pros) are a lot less reluctant to give you money if they can get out on an instant's notice.

Lockups are really only necessary for strategies such as event-driven or distressed assets. The hedge fund industry mostly uses lockups to keep control of its assets. Recall how the recent ('06) Greenwich-based fund went guts-up and tried to manipulate its reports to shareholders to have the latter miss a redemption deadline.

Brian Haag adds:

If the funds are algorithmically managed, they are a short. Fixed systems die. If the funds are actively managed, they are a short. They will not attract the talent that 2/20 type arrangements will, and will thus be the mark at the table.

This whole "you can replicate any hedge fund strategy by adding beta and a few formulas" meme is no different from the "You can beat Wall Street at its own game!" type hucksterism so prevalent in the late 90s. It's just marketing crapola. While the base idea may be sound, that you don't have to get involved in hedge funds to receive average returns, so what? The only possible outperformance in products like these is relative to managers with subpar returns. It's all just another way for the industry to sell average performance.

Managers who do add alpha are very happy about this whole development. It's another source of edge. One needs to look no further than the "Goldman roll" in commodities to see an example.

Charles Sorkin adds:

I have been offered structured notes (intended to be re-offered to our customers) that pay interest based on the Tremont hedge fund indices. Depending on the degree of index participation desired, investors have the option to have total return floored at zero percent (principal guaranteed, like a bank note). Naturally, the secondary market for such a thing is limited, but it's still better than a hedge fund lock-up. Moreover, the issuer is generally an AA-rated large European bank.

Need to get more aggressive? Just buy 'em on margin…

Henrik Andersson adds:

Some of these structured products, which are particularly popular in Europe, are selling with a participation rate of 100% and no Asian etc. This is strange since it seems you get the put for free; but in these cases the cost of the option is most likely taken from the fees of the underlying funds.


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