NEW YORK (HedgeWorld.com)–Standard and Poor’s has teamed up with PlusFunds to create an investable hedge fund index expected to launch in the third quarter.

The new S&P Hedge Fund Index is intended to establish a standard benchmark and medium for investing within the alternative investment asset class, which is rapidly gaining global acceptance among institutional investors such as pension funds, banks and insurance companies.

The index itself will be comprised of 40 individual hedge funds, divided into three broad sub-indexes–arbitrage, event-driven, and tactical. Underlying fund strategies included are global macro, long/short equity, managed futures, special situations, merger arb, distressed, fixed-income arb, convertible arb and equity market-neutral.

Bermuda-based PlusFunds will act as investment manager for the fund, which will be accessible to institutional investors and high-net-worth investors. A third-party partner, Somerset, N.J.-based Derivatives Portfolio Management will verify fund valuations and Albourne Partners Ltd., London, will lead due diligence screening.

To be included in the S&P Hedge Fund Index, a hedge fund must pass due-diligence muster. Funds will be measured to ensure a track record is not marred by style-drift. Funds must also provide daily transparency. “There will eventually be about 40 managers, a number we’re getting close to,” said PlusFunds principal Chris Sugrue.

From the point of view of established players in the hedge fund industry, the new S&P Hedge Fund Index might look more like a fund of funds than it does an index. But the new product is different in another way, according to Mr. Sugrue. “The fee structure is less than you might expect from a fund of funds. The only other fees on top of those for the underlying managers is a additional cost that comes out to about 90 to 95 basis points (per year),” Mr. Sugrue said.

“On the investment side, individual funds will be running money in managed accounts,” Mr. Sugrue said. “From the investors point of view, it will be a standard T+1 situation in that valuation numbers will be available to be viewed in aggregated form daily.

“That’s important because you’re applying the principals and practices that are standard to the traditional side,” he said. “This is about making hedge funds something less exotic and something more domesticated. … Some of the strongest interest we have seen early on has been from U.S. mutual fund complexes who have wanted to see something like this,” Mr. Sugrue said.

An index committee managed at Standard & Poor’s will meet regularly to review the hedge funds in the index and rebalance if necessary. S&P expects to announce the index composition and methodology by the third quarter.

“One of the things that will be looked at in maintaining the index is a manager’s excess capacity,” said Paul Aaronson, an executive managing director at Standard & Poor’s. “A lack of capacity is one of the reasons a manager might be removed from the index. On the other hand, we’ve made efforts to ensure that these won’t be funds below a certain level of capitalization either.”

The familiarity of the S&P name in benchmarking is expected to grab the attention of institutional investors. The company suggests that the hedge fund industry’s growth thus far has been remarkable but has been somewhat constrained by the fact that institutions have been reluctant to put money with managers of privately run funds, which typically lack transparency.

A number of funds that might otherwise have been in the index were omitted because managers were either unable or unwilling to disclose daily NAVs, a prerequisite for inclusion, Mr. Aaronson said.

Reflecting the fact that most hedge fund portfolio teams are U.S.-based, the new S&P alternative benchmark will follow suit. “The majority of the managers may be in the U.S., but that’s not to say that the scope of the underlying investments represented in the index will be limited geographically. They won’t. Broadly speaking, they’re global,” Mr. Aaronson said.

Emerging markets is not included as a distinct group within the new benchmark’s sub-indexes. But Mr. Aaronson said that does not mean that hedge funds with such exposure would be excluded from the indexing effort.

Also there is nothing exclusionary about being included in the index. That is to say that fund managers included in the index are not prevented from raising capital through other vehicles that trade similar styles.

Standard & Poor’s and its business partners in the index are probably hoping the new S&P Hedge Fund Index will whet institutional investors’ appetite for additional alternatives.

“The index will be used for the fund–they’re really the same thing at this point,” Mr. Sugrue said. “But down the road, the index will be used as a basis for building other products–ones that include principal protection, for instance.”

From S&P’s perspective, the new index–independent of the PlusFunds-licensed product–will serve as a benchmark for the hedge fund industry.

“We looked around and saw that there was a gap in the market when it came to hedge funds, and we recognized an index like this would be valuable,” Mr. Aaronson said. “It complements our existing indexes, which include commodities as well as equities.”

“We saw that there were other hedge fund indexes that existed, but ours is the first that looks at daily valuations. That combined with the rigorous index-building standard S&P brings to the table, makes this something that we think will make a valuable benchmarking tool for alternative investments,” he said.