Historically, the only way an investor could gain exposure to hedge fund “alpha” was to invest directly with a hedge fund or a hedge fund-of-fund. To succeed an investor had to either believe that they could choose hedge funds well or, if not, believe that by giving up that responsibility to someone else (for an extra layer of fees) the returns from expert selection would more than make up for the higher fees.
An entire industry has emerged around hedge fund manager due diligence and selection. At one end are the consultants who help the endowments, institutions and family offices that can afford their services with customizing their hedge fund allocations to fit their specific needs. At the other are fund-of-funds who offer pre-packaged and managed allocations to specific hedge funds they select in exchange for an extra 1% per year and an extra 10% of new profits on top of the 2%/20% fees of the underlying funds.
Elevating the price to the investor for incorrect manager selection is the fact they can not withdraw their investment at will. Hedge funds have “lockups” that range from 90 days to a couple of years or more which prevent an investor from redeeming their investment quickly. Simply put, when it comes to hedge fund investing, manager selection is everything.
Enter “Alternative Beta”
The difficulty in manager selection and the lack of transparency from hedge funds in general has led to the emergence of innovative investment products that offer investors the opportunity to remove manager selection from the equation. Tagged as “alternative beta”, these products (many of which are available as ETFs) attempt to replicate the statistical return and risk characteristics inherent in an index of hedge funds. The premise is that by replicating the average return/volatility/skew characteristics of an index of hedge funds (i.e. the “beta” in a index of “alternatives”), investors can still achieve hedge fund “like” returns without the headaches of manager selection, fees and lockups.
The problem however is that average hedge fund returns are not very good (see table 1). Looking at non-investable (HFRI) and investable (HFRX) variants of Hedge Fund Research's Equity Hedge Total Return Index, we see annualized returns since 2000 in the 3% to 6% range. In addition, the investable version has underperformed the S&P500 significantly over the 1, 3, and 5 year periods. One would expect an investor interested in hedge fund exposure to seek investment returns of top hedge funds not those with average returns (see table 2).
“Alternative Alpha”
But why would you want to replicate a manager's beta exposure (i.e average returns) when you can just as easily replicate the “alpha” in the manager's long positions instead? There are several academic papers by established researchers that demonstrate the efficacy of following hedge funds and institutional investors based on their public disclosures. AlphaClone's own research (stay tuned for new academic white paper) and actual investment results have humbly added to the evidence that it is possible to generate statistically significant excess returns (see table 3).
The strategies above include three basic elements; 1) position replication, 2) dynamic hedging, and 3) automatic rebalancing. The three elements combine to take advantage of upside volatility, mitigate downside volatility and introduce rigid trading discipline. Now for the first time, we're taking these principles and putting them into a passive rules-based index.
AlphaClone is pleased to announce the publication of the AlphaClone Hedge Fund Long/Short Index [Bloomberg/Reuters tickers: ALPHACLN]. The index seeks to track the performance of US equities selected based on a proprietary Clone Score methodology developed by AlphaClone. Completely rules-based the index recalculates Clone Scores bi-annually and rebalances long positions (up to 100) quarterly. To manage downside volatility the index will employ AlphaClone's dynamic hedge mechanism. The mechanism reduces maximum drawdowns, volatility and overall market correlations.
The strategy's backtested performance since 2000 (see table 4) has out performed the DJCS Long/Short Equity Index six fold on an annualized basis. The strategy's risk adjusted returns are higher with lower maximum drawdowns over the 3 year, 5 year and since 2000 periods. So far this year to 7/31/2011, the strategy has outperformed the DJCS Long/Short index returning 8.8% vs. 0.3% for the benchmark and 3.9% for the S&P500TR.
“Alternative Alpha” ETF
In early 2012, AlphaClone will be deploying an ETF based on this index. Needless to say we're very excited about the introduction of what we believe will be a ground breaking product offering. The strategy is tailored toward advisors and their clients who want access to a risk managed “virtual fund of funds” strategy constructed based on the disclosures of the world's foremost investors but without the high fees and lockups and with all the flexibility and scalability inherent in exchange traded funds.
If you're a financial advisor or client who is interested in learning more about our offering including the timing of its introduction and would like us to contact you with more information, please complete the following form and we'll respond promptly.
IMPORTANT DISCLOSURES FOR ACTUAL PERFORMANCE RESULTS
Actual performance figures are unaudited estimates generated by AlphaClone, LLC, and are subject to modification. Performance is in U.S. dollars, includes the reinvestment of dividends and is net of trading expenses and management fees (1.5% per year combined). Past performance is not a guarantee of future returns. AlphaClone Core Strategies seek capital appreciation as their investment objective. This communication does not constitute an offer or a solicitation to invest with AlphaClone, LLC. Index comparison returns are shown with dividends reinvested were available. ** Indicates strategy is risk managed.
IMPORTANT DISCLOSURES FOR BACKTEST PERFORMANCE RESULTS
Backtesting is the process of evaluating a core strategy by applying it to historical data. Backtested performance results are provided for purposes of illustrating historical performance had a core strategy had been available during the relevant period. Backtested performance results are hypothetical and have inherent limitations. AlphaClone makes no representation that any core strategy will achieve performance similar to any backtested performance results. Actual results could differ materially from backtested performance and future results could differ materially from backtested performance. Past performance is no indication or guarantee of future results.
Backtested performance results: (i) do not reflect the deduction of any management fees or trading commissions; (ii) are not based on actual trading and do not reflect any market impact of buying and selling securities, trade timing and security liquidity; (iii) are updated on a quarterly basis following the filing of public disclosure reports by certain hedge fund and institutional money managers; (iv) reflect the closing prices on the rebalance date; (v) reflect prices that are fully adjusted for dividends and corporate actions (e.g., stock splits); (vi) do not reflect any public disclosures filed after a rebalance date; (vii) reflect the historical results of securities which have been, been are no longer, publicly traded; and (viii) reflect the historical results of money managers who are no longer filing public disclosure reports.
AlphaClone does not represent that backtested performance information is accurate, complete or current, and AlphaClone has no liability with respect thereto. The AlphaClone core strategies are subject to change without notice and AlphaClone has no obligation to update you as to any such changes. The information provided herein comes from what AlphaClone believes to be reliable sources. AlphaClone, however, makes no representations as to its reliability or accuracy, and you should undertake independent analysis to ensure the accuracy of the information.
