The Federal Reserve has decided to keep its $85 billion bond buying program in place and the stock market which was in the consolidation mode for the last few weeks, has resumed its upward march. With the punch bowl still on the table, the stock market party may go on some time. (Read: 3 ETF Winner from the No Taper Shocker)
As a result of stock market optimism, investors have continued to pour a lot of money in US equity funds this year, but most of the money has gone to top few ETFs. The largest ETF SPDR S&P 500 ETF (SPY - ETF report) now has a whopping $148.2 billion in AUM. On the other hand, many smaller ETFs, particularly the ones that focus on certain ‘niche’ strategies continue to remain out of limelight.
Some of these ‘niche’ ETFs provide access to certain obscure corners of the investment world that are otherwise not accessible to ordinary investors. One such area is hedge fund investing.
The hedge fund industry with about $2.4 trillion in assets is accessible only to very wealthy investors as these funds generally require minimum investments of $250,000 and also have limits on cash withdrawals. (Read: 3 Ultra-Cheap ETFs for Value Investors)
Hedge fund managers use very different investment strategies but they do not always hedge their exposures as the name would suggest. In fact many of them have high leverage and invest in riskier assets, though many may have many counterbalancing trades.
Further, hedge fund investing is expensive as they usually charge an annual asset management fee of 2% and a performance fee of 20% of fund’s profits (2 and 2 fees). Also, their performance may not justify the steep fees that they charge.
Hedge Fund Research Inc.'s HFRI Fund Weighted Composite Index, which tracks the broad hedge-fund industry, gained 3.8% this year through August (net of fees), while the S&P 500 index gained 16.2% with dividends.
How to invest like Hedge Funds
Most investors would like to invest like George Soros, Carl Ichan and John Paulson and there are some ETFs that provide access to investing secrets of these stalwarts, without charging the hefty fees that their funds charge. (Read: 3 Unknown ETFs that continue to crush SPY)
All hedge funds with more than $100 million in U.S. equity investments are required to publish their holdings in a publicly available document called the 13 F. Some ETFs look for best investment ideas from these holdings and replicate them. While not all of them of have been successful, we have highlighted two ETFs that have handily beaten the broader hedge fund industry as well as the stock market.
Global X Top Guru Holdings Index ETF (GURU - ETF report)
GURU uses a proprietary methodology to compile the best ideas from a select pool of hedge funds where the 13F information is most valuable. They exclude hedge funds with high turnover.
The fund aims to generate alpha vs. benchmark equity indexes and rebalances quarterly
The product launched in June 2012, has attracted $147.5 million in assets so far. It charges 75 basis points in expenses per year. Pandora, Cumulus Media and US Airways are the top holdings at present.
Daily average trading volume is about 50,000 shares per day.
AlphaClone Alternative Alpha ETF (ALFA - ETF report)
This ETF is based on the AlphaClone Hedge Fund Long/Short Index. The index uses AlphaClone’s proprietary “Clone Score” methodology to aggregate the hedge funds ideas on a quarterly basis. Clone scores, which are calculated bi-annually, are based on hedge funds managers’ performance. Index constituents are equally weighted but can have overlap bias.
The index also has a hedge mechanism built in, which is triggered on or off when the S&P
500 index crosses its 200 day moving average at any month end. If the market goes down, the index goes from long-only to market hedged (50% short exposure to S&P 500).
Launched in May last year, this product has been able to garner only $17.5 million in assets so far. It has 78 holdings currently; Twenty-First Century Fox, American International Group and Valeant Pharmaceuticals being the top holdings.
ALFA is slightly more expensive than GURU, charging 95 basis points in expenses. Further due to low trading volume of just about 5,000 shares, trading costs may be higher due to high bid-ask spread.
The Bottom Line
As can be seen from the chart above, these two ETFs have been outperforming the broader market over the past few months. Looking at the one-year performance, GURU and ALFA have returned 37% and 23% respectively compared to about 20% return for SPY.
GURU has obviously has delivered a much better performance at a lower cost. One possible advantage of investing in ALFA is its hedging strategy. If the market suddenly turns bearish, ALFA may be able to provide some protection to the portfolio.
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