Hedge funds are off limits to many investors, but with exchange traded funds, the average retail investor has been benefiting from top smart-money picks. Still, traders should understand how the funds work and potential limitations.
For instance, the Global X Guru Index ETF (NYSEArca: GURU) and AlphaClone Alternative Alpha ETF (NYSEArca: ALFA), funds that both try to copy hedge funds’ top stock picks, have outperformed the broader stock market over the past year, gaining 32.1% and 33.9%, respectively, compared to the S&P 500 index’s 24.3% increase.
“If you know what every large investor in the U.S. owns in his portfolio on a quarterly basis, there is value in that information,” Global X head Bruno del Ama said in a Reuters article.
However, critics are quick to point out that these hedge-fund clones are not able to mirror the day-to-day hedging that is suppose to mitigate short-term risks.
The hedge fund ETFs track holdings selected from quarterly hedge fund disclosures. The SEC Form 13F, or Information Required of Institutional Investment Managers Form, is a quarterly filing required of institutional managers with over $100 million in qualifying assets. The filing contains information on the manager’s list of recent investing holdings, which provide the public a glimpse of how the heavy weights are moving around the changing markets.
Since the ETFs’ holdings are based on numbers from the previous quarter, potential investors should be aware that the ETFs’ positions may become stale in a quickly changing market. Additionally, the ETFs may not perfectly reflect hedge fund positions as many hedge funds utilize derivatives, which are not required to be disclosed.
“What you end up with is a fairly different entity,” compared to a hedge fund, John Rekenthaler, vice president of research at Morningstar, said in the article. “You give up quite a bit when you’re looking at filings, which is old information, and long-only information.”
The ETFs, though, allow anyone to access hedge fund strategies at fees that are paltry compared to those charged by hedge funds. GURU comes with a 0.75% expense ratio and ALFA shows a 0.95% expense ratio. In comparison, a hedge fund typically cost more than a mutual fund, charging a 2% or more management fee and an incentive fee that can range anywhere between 10% to 20% of total profits. Additionally, hedge funds require very large initial minimums to invest.
“We wanted to be as accessible as possible,” AlphaClone founder Mazin Jadallah said in the article.
For more information on ETFs that replicate hedge fund strategies, visit our hedge fund category.
Max Chen contributed to this article.