The Pros and Cons of Passive
Hedge Fund Replication
EDHEC Risk and Asset Management Research Centre
The remarkable rise of the hedge fund industry in the last decade of the twentieth century would not have been possible without the great demand of wealthy private clients for sophisticated investment opportunities. Institutional investors, by contrast, long remained reluctant to invest in hedge funds. Although clearly drawn to the returns and the risk reduction potential of these investments, they have only recently started to shift a part of their assets to hedge funds. The main reasons for this reluctance are the high fees successful hedge fund managers charge their clients and the relative opacity of the funds, along with the operational risks associated with investments in weakly regulated entities.
The conflict between the institutional investor’s requirements for highly transparent investments and the black box nature of hedge funds has prompted attempts to obtain hedge fund-like returns without actually investing in hedge funds. Investment banks seized the opportunity and have started to create synthetic hedge fund products whose aim is to replicate hedge fund-like returns at lower cost.
Whether these replication products really offer replication of actual hedge fund returns remains to be seen, however. The academic debate, as reflected in a recent publication of the EDHEC Risk and Asset Management Research Centre (Amenc et al. 2007), revolves around two major issues:
The objective of this paper is to describe practitioners’ views on hedge fund replication products. For this purpose, the EDHEC Risk and Asset Management Research Centre asked practitioners for their opinions. It is found that many investors share the concerns of academics. They doubt that replication products can really deliver the benefits they promise. Moreover, hedge fund replication products are still new to many of the respondents, and very few have hands-on experiences with this new asset class.
Click here to view the full report (1.28MB)
The conflict between the institutional investor’s requirements for highly transparent investments and the black box nature of hedge funds has prompted attempts to obtain hedge fund-like returns without actually investing in hedge funds. Investment banks seized the opportunity and have started to create synthetic hedge fund products whose aim is to replicate hedge fund-like returns at lower cost.
Whether these replication products really offer replication of actual hedge fund returns remains to be seen, however. The academic debate, as reflected in a recent publication of the EDHEC Risk and Asset Management Research Centre (Amenc et al. 2007), revolves around two major issues:
What is the best means of replicating hedge fund returns?
Is the replication thus obtained really a close approximation of hedge funds?
The objective of this paper is to describe practitioners’ views on hedge fund replication products. For this purpose, the EDHEC Risk and Asset Management Research Centre asked practitioners for their opinions. It is found that many investors share the concerns of academics. They doubt that replication products can really deliver the benefits they promise. Moreover, hedge fund replication products are still new to many of the respondents, and very few have hands-on experiences with this new asset class.
Click here to view the full report (1.28MB)
