Hedge fund replication in turbulent markets

Abstract

Purpose

Hedge fund replication gained considerable attention during the period surrounding 2007 when it was anticipated to become for hedge fund investors what index funds are for equity investors. The hedge fund replication concept only lacked a track record. This paper aims to present an updated evaluation.

Design/methodology/approach

Performance is evaluated on both a raw‐return basis and a risk‐adjusted basis using Fung and Hsieh's 8‐factor model. Particular emphasis is given to analyzing the performance of these products during the financial crisis and to highlighting the specific characteristics that distinguished them from their hedge fund cousins during this period.

Findings

The results show that the hedge fund replication space is definitely proving its existence as a credible hedge fund investment alternative. Talented hedge fund managers will always be in high demand, but they may have to just prove their high compensation a bit harder.

Research limitations/implications

Although this study is based on a short sample period, the results indicate that hedge fund replication products delivered returns that were at par with the returns of hedge funds. The replication products performed comparatively well during the crisis probably as a result of having less exposure to illiquid assets.

Originality/value

To the best of the authors' knowledge, this article uses the most extensive data set of 22 hedge fund replication products to analyze their performance.

Citation

Tuchschmid, N.S., Wallerstein, E. and Zaker, S. (2012), "Hedge fund replication in turbulent markets", Managerial Finance, Vol. 38 No. 1, pp. 67-81. https://doi.org/10.1108/03074351211188367