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1、Hedge Fund ReplicationHossein KazemiCISDMWhite Bear Partners, LLCkazemisom.umass.eduNovember 16, 2007Alphas and Betas of Hedge FundsoHedge funds are marketed as absolute return investment products.nMost of the returns are supposed to come from idiosyncratic bets made by managersnSystematic component
2、s of returns are supposed to be small.oEvidence provided by academic research during the last decade shows otherwisenDiversified portfolios of hedge funds have significant exposures to various factorsnThe exposures are in some instances different from those provided by traditional asset classesnA si
3、gnificant portion of returns is due to exposures to these sources of risk-return Betas and Alphas of Hedge FundsoAcademic research has helped change the dominant paradigm that hedge funds are pure absolute return investment products Traditional AssetsBeta ReturnAlpha ReturnTotal ReturnAlternative As
4、setsBeta ReturnAlpha ReturnTraditional AssetsBeta ReturnAlpha ReturnAlternative AssetsBeta ReturnAlpha ReturnDominant Paradigm: 1960-2000 Emerging Paradigm: 2000-Present LOWMEDIUMHIGHNote: +/- indicates positive or negative exposureConvertible ArbitrageEquity Market NeutralEvent DrivenDistressed Sec
5、uritiesMerger ArbitrageEquity Long/Short Percentage of Return Volatility Not Explained by StrategySharpe RatioLeverageReturn to StyleVolatility of ReturnDownside RiskExposure toEquity Index ReturnEquity Index VolatilityEconomy Wide Credit RiskInterest Rates+-+-+-+-Summary of expected exposure for HF
6、 StylesCommon Sensitivities To Market FactorsEvidence on the Alternative Betas: Hedge EquityEvidence on the Alternative Betas: Fund of FundsAlternative Betas & AlphasoAlternative betas have come to represent systematic exposures of hedge fund strategies to accessible sources of beta returns.oHedge f
7、und replication products attempt to replicate returns attributed to alternative betas.oReplication products are not meant to replicate the alpha of hedge funds (if there is any). Alternative Betas & AlphasoAlternative betas are not constant and replicating strategies attempt to capture dynamics of t
8、hese betas.oRecent increase in hedge funds beta is not a disturbing fact because markets have been rising in recent years. Will the betas decline when markets begin to decline?oGraph on the next page shows that hedged equity managers reduced their betas as S&P500 declined during 2000-2002, and incre
9、ased their betas in 2003 as markets began to recover.Changing Betas of Hedge FundsBenefits Replication StrategiesoWBP replication strategies provide the following benefits:nLiquidity without adverse performance impact: Most liquid securities are employed.nImmediate diversification: ETFs, futures con
10、tracts and other diversified assets are used.nTransparency of the product: The algorithm is completely self-contained and transparent.oResults: Low startup (due diligence) cost. No illiquidity cost. No “style drift”. Applications of Replication StrategiesoLong-term investment & tactical asset alloca
11、tion: Because of its liquidity, the product could be used in a TAA program.oHedging of existing positions: Because the product can be shorted, it can be used to hedge illiquid long positions in certain hedge fund strategies.oCash management: Because of its liquidity, the product can be used to manag
12、e cash.oETF Creation: The product could be used to create an Exchange Traded Fund.Approaches to ReplicationoFactor Replication: A portfolio of liquid assets is created to track the time-series properties of a target hedge fund index.nBetween 30%-90% of time series variations of hedge funds can be ex
13、plained by the replicating portfolio.nReplicating portfolios have negative annual alphas between 15-100 bps.oMoment Matching: Dynamic hedging approach is employed to match the return distribution of a given target. The correlation between the target and the portfolio could be very small.Performance Comparison (Beware of Pro Forma Pre 07)Performance Comparison (Beware of Pro Forma Pre 07)Live Return of WBP, LLC
