Hedge Funds of Funds: A Guide for Investors

14

Hedge Fund Indices and Replication

14.1 OVERVIEW

In recent years there has been a significant attempt to offer access to the hedge fund universe by indexation and replication. In the case of the former approach, an index compiler will calculate the overall return of a wide range of underlying hedge funds and reflect this in a hedge fund index, but also produce an investable version of this index as an investment vehicle where the returns can actually be accessed by an investor. In the case of replication, a more recent innovation, a provider will attempt to replicate hedge fund returns by taking exposure to factor based returns and/or other financial instruments with the aim of allowing investors to experience hedge fund-like returns without the cost, lack of transparency, operational risk or illiquidity. In this chapter I will discuss the benefits and downsides of investing through investable hedge fund indices and replication techniques.

14.2 HEDGE FUND INDICES

A hedge fund index is an entity that seeks to reflect the returns of the hedge fund universe. Such indices could be used as benchmarks or comparators for hedge fund and hedge fund of funds performance or just serve as a reflection of hedge fund returns. Most hedge fund indices are uninvestable, in as much as their returns could not be replicated on invested capital due to the fact that many of the constituent hedge funds are closed to new investment. Some uninvestable hedge fund indices do have investable versions that ...