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How to Beat Hedge Funds with ETFs

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The rally in the U.S. stock market has been accompanied by the hedge fund industry. This is because hedge funds (as depicted by HFRI Fund Weighted Composite Index) gained 5.5% in 2016, representing the best return since 2013. As a result, hedge fund assets increased by $121 billion, the largest annual increase since 2014, surpassing the $3 trillion milestone for the first time.

Fixed income-based Relative Value Arbitrage (RVA) strategies funds led the way higher with asset growth of $43.9 billion. This was followed by asset growth of $32.4 billion for event-driven strategy funds, $25.4 billion in macros strategies, and $20 billion for equity hedge strategies.

The impressive gains came despite large investors’ redemptions of $70.1 billion in 2016, marking the largest annual outflow since 2009.

Given the solid performance, the appeal of investments like hedge funds returned. Though hedge funds use unique methods or offer exposure with lower risk strategies to produce some level of outperformance, these come with high cost and are illiquid. Additionally, hedge funds are accessible only to wealthy investors or institutions as these generally require minimum investments of $250,000 and have limits on cash withdrawals.

To overcome these drawbacks, investors can easily tap the growing space through basket form. Hedge fund ETFs replicate investing styles and predictions of hedge funds, providing a solid and well-diversified portfolio, which seek to outperform the broader market. These have high levels of liquidity and are easily accessible like stocks. Further, these charge lower fees than what investors have to pay in the ‘true’ hedge fund space (see: all the Hedge Fund ETFs here).

As a result, we have highlighted some of the popular funds that could make for an exciting choice in this corner of the ETF market. These utilize hedge fund strategies but differ in one way or the other. This suggests that investors should be able to find a good choice that matches their style and needs in this intriguing space:  

IQ Hedge Multi-Strategy Tracker ETF QAI

This is the most popular ETF in the hedge fund space and tracks the performance of the IQ Hedge Multi-Strategy Index. The fund uses a variety of strategies into its portfolio including long/short equity, global macro, market neutral, event-driven, fixed income arbitrage and emerging markets. It allocates heavy weights in fixed income products like BSV and LQD, which collectively account for 40.5% share. This product has amassed over $1.2 billion in its asset base and trades in average daily volume of 177,000 shares. It charges 75 bps in annual fees and added 2.7% over the past one year (read: Are Hedge Fund ETFs Good Bets for Only Uncertain Times?).

Global X Guru Index ETF GURU

This fund seeks to generate alpha over the broad market by investing in highest conviction ideas from a select pool of hedge funds. It follows the Solactive Guru Index, holding 52 stocks in its basket with none accounting for more than 2.31% of assets. Pandora Media, Netflix and Charter Communications are the top holdings at present. The portfolio is tilted toward technology and consumer discretionary at 26% each, closely followed by healthcare (11%) and financials (10%). The ETF has accumulated $55.3 million in its asset base while volume is light exchanging 18,000 shares in hand. It charges 75 bps in annual fees and surged 19.5% over the past one-year period.

AlphaClone Alternative Alpha ETF ALFA

This fund tracks the AlphaClone Hedge Fund Downside Hedged Index. The benchmark uses a proprietary ranking system, ‘Clone Score’, which ranks hedge funds and institutional investors based on the efficacy of replicating their publicity disclosed positions. It 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).

Holding 68 securities in its basket, the fund is pretty spread out across components with none accounting for more than 5.22% share. Amazon, Simon Property and Apple are the top three holdings while technology dominates the fund’s portfolio from a sector perspective with 29% share. The ETF has garnered $35.2 million in its asset base while trades in volumes of around 11,000 shares per day. Expense ratio comes in at 0.95%. ALFA is up 1.6% over the past one-year period (read: Goldman Sachs Files for 2 New ETFs).

ProShares Hedge Replication ETF (HDG - Free Report)

This ETF follows the Merrill Lynch Factor Model- Exchange Series, which provides the risk and return characteristics of the hedge fund assets class by targeting a high correlation to the HFRI Fund Weighted Composite Index. This is accomplished by utilizing a systematic model to establish weighted long or short (in certain cases long or flat) positions in six benchmarks including the S&P 500 Total Return Index, the MSCI EAFE US Dollar Net Total Return Index, the MSCI Emerging Markets US Dollar Net Total Return Index, the Russell 2000 Total Return Index, three-month U.S. Treasury bills, and ProShares UltraShort Euro ETF.

HDG charges 95 bps in fees per year from investors. The fund has accumulated only $32.2 million in its asset base while volume is paltry at about 5,000 shares. The ETF gained 5.6% over the past one-year period.

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