What's Inside Your Hedge Fund ETF?

HDG’s index algorithm currently calls for a large allocation to short-dated Treasury bills as well as an extensive array of equities. All told, the portfolio holds nearly 2,500 stock positions. And, despite a substantial offsetting short position through S&P 500 swaps, HDG remains tightly correlated to the U.S. equity market.

Taking stock

The trouble with these ETFs is their ingredient lists. While the ETFs are certainly transparent—each holding is disclosed daily—investors don’t get attributions. They don’t know how much exposure they are actually getting to market-neutral, event-driven or any of the other strategies at any given time.

How does one choose a fund without that information? After all, it’s the strategy allocations that determine returns.

Speaking of returns, how’s the multi-strategy approach fared over the past year? Has the switch from long-only equities paid off for investors? 

Well, yes and no. From the chart below, we can see that all three of these ETFs have underperformed the S&P 500 on a total return basis. From this, you might think the hedge strategy’s been a bust. Interim gains aren’t the only measure of an investment’s performance, however. There’s risk to be taken into account. Across the board, swapping into a multi-strategy position substantially reduced volatility for investors, by more than half, but the hedge fund ETFs haven’t yet been able to crank out Sharpe ratios better than that of the S&P 500. Keep that word “yet” in mind.

(Click on image to enlarge)

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What’s next?

Are we too impatient with the hedge fund strategy? Better yet, is there something we can do to goose up risk-adjusted returns? To answer those questions, we need to dig into the ETF returns to identify their most significant contributory strategies. Once we know those, it may be possible for us to adjust the multi-strategy approach with over- or underweights.

There are a number of single-strategy hedge ETFs we can use as benchmarks in our return attributions.

The IQ Hedge Long/Short Tracker ETF (NYSE Arca: QLS) is an index tracker that takes long and short positions primarily in ETFs and ETF swaps. The fund’s index methodology combines ETFs and derivatives covering the U.S. and foreign equity markets as well as high-grade debt and bank loans. Not surprisingly, QLS is “half way” correlated to the U.S. stock market with a lifetime coefficient of .46; beta, at .43, is also middling.

Large-scale economic trends are exploited by so-called global macro funds such as the IQ Hedge Macro Tracker ETF (NYSE Arca: MCRO). Passively managed, MCRO is geared to emulate the returns of macro and emerging markets hedge funds with a .66 correlation to the U.S. equity market and a .30 beta.

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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