Get a shortcut to hedge fund gains with ETFs

FOLLOWING a terrible 2008, hedge funds managed to bounce back last year both in terms of assets under management and performance. In 2009, the Credit Suisse/Tremont hedge fund index recorded annual performance of 18.57 per cent compared to a loss of 19.07 per cent the previous year, largely as a result of the financial crisis. And in terms of growth, PerTrac, an investment analysis firm, found in a recent study that assets under management rose 5.5 per cent last year compared to an eye-watering drop of 36.1 per cent the previous year.

But as providers are fond of repeating, past performance does not guarantee future returns. So will hedge funds be as successful in 2010 as they were in 2009? Credit Suisse’s annual hedge fund investor survey, which was published earlier this week, would certainly suggest so. It shows that investors and managers alike are generally optimistic about the growth prospects of the industry and expect that assets under management will grow from an estimated $1.64 trillion at the end of 2009 to as high as $1.97 trillion by the end of this year. And hedge funds have got off to a good start in 2010, separate data from Credit Suisse shows. Products that aim to replicate the performance of the Credit Suisse/Tremont Hedge Fund Index are already up 1.83 per cent year-to-date.

But while hedge funds have propelled themselves back into the news and into positive territory, it is extremely difficult for the individual investor to gain exposure to their performance. Investing in hedge funds, which tend to be more opaque and expensive than your average fund, used to be reserved for large institutional investors such as pension funds and very high net worth individuals.

This is changing, however. Individuals can now access hedge fund performance through funds of funds and more recently in Europe, hedge fund exchange-traded funds (ETFs). Funds of funds are products made up of various hedge funds so they offer immediate diversification but these are still relatively illiquid investments and often require large minimum investment amounts.

Exchange-traded funds which offer exposure to hedge funds are therefore increasingly popular because they are more transparent than both funds of funds and the hedge funds themselves and performance is updated daily. They also tend to be cheaper than the average hedge fund in terms of fees.

At the start of last month, hedge fund Marshall Wace launched its ETF listed in London and which is designed to track its flagship Tops fund strategy. The ETF will track an underlying asset designed to reflect the holdings six existing Marshall Wace Tops funds. Previously, these were proprietary hedge fund strategies exclusively available to institutional investors and high net worth individuals. Individuals will now be able to gain exposure to these strategies through the ETF for an operational fee of 0.25 per cent per annum and the standard 1.5 per cent annual charge and 20 per cent performance fee for the underlying structure.

However, this only gives investors exposure to the performance of the strategies employed by the hedge fund rather than the performance of the hedge fund itself. Deutsche Bank’s ETF division db x-trackers launched its db Hedge Fund Index ETF at the end of 2008 and saw $1.2bn raised in 12 months with a total expense ratio of 0.9 per cent and a minimum investment of €10 per ETF share.

Rather than giving strategy exposure, it uses Deutsche Bank’s Hedge Fund Index as its underlying index, which is diversified across five core hedge fund strategies – equity hedge, equity market neutral, event driven, systematic macro and credit and convertible – and 37 funds. Rebalanced quarterly to reflect the wider industry, the index is derived from an underlying hedge fund platform, which reduces the liquidity problems typically associated with investing in hedge funds.

So far, there are just these two hedge fund ETFs (db x-trackers officially has three variants of its hedge fund ETF, denominated in dollars, pounds and euros) but there are plenty listed in the more mature US market. With investors and managers anticipating growth in the hedge fund industry this year both in terms of performance and assets under management, individual investors should take a closer look at using funds of funds and exchange-traded funds as a means of gaining exposure to hedge funds’ progress.