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Portfolio > Alternative Investments > Hedge Funds

Exchange-Traded Hedge Fund Indexes Next Step

By Staff Writer

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NEW YORK (HedgeWorld.com)–Now that several investable hedge fund indexes have become available, exchange-traded vehicles that track such measures might not be far off, despite the complexity of fitting hedge funds into an ETF format.

“That is just a matter of time,” said Stephen Jupp, who works on the Credit Suisse First Boston/Tremont hedge fund index. He explained that the liquidity issue can be solved, possibly by using derivatives and structured products. “If your index is big enough, I’d imagine you could take that liquidity risk,” he added.

ETFs, baskets of securities that mimic the performance of a bond or stock index, are bought and sold throughout the day. These take different forms, and regulations probably will prevent hedge fund versions of some popular types of ETFs such as Spiders, said Peter Roffman, from Standard and Poor’s hedge fund index group.

“It might be a challenge for that particular format,” he said. “But over time, there could be exchange-trades hedge fund indexes in other formats.”

Fund of Funds

“There will always be slight differences between traditional ETFs and hedge fund-based products,” said Simon Midgen from Morgan Stanley Capital International. “ETFs based on shares have intra-day liquidity–that is a long way from the hedge fund world.”

However, investable indexes already have gone well beyond the industry’s typical quarterly or monthly redemption policies. For example, MSCI offers weekly liquidity. Both MSCI and S&P provide indexes for large numbers of conventional ETFs, and a hedge fund version is an obvious extension of this type of vehicle.

“There will be many products introduced that have similar functions to ETFs, that allow investors to gain exposure to the market and create other products, such as options and derivatives, which can be used to control the risk of exposure to hedge funds,” Mr. Midgen added.

Indeed, some critics of hedge fund indexes have pointed out that the measures resemble ETFs rather than market benchmarks. “They’re the equivalent of exchange-traded funds that attempt some level of style purity,” Jon Lukomnik, managing partner at Sinclair Capital and a former deputy comptroller of New York City, argued. “Some are, in effect, over-the-counter ETFs because people can trade their derivatives.”

Investable indexes are similar to–and for many investors might be a close substitute for–funds of funds. Some fund of funds managers scoff at the idea that a passive index tracker can deliver performance in the hedge fund world. These arguments echo past debates between active and passive investing proponents in the mutual fund arena, although the issues are not identical.

But some industry people see hedge fund ETFs as a potentially very convenient tool and look forward to their becoming available. For instance, funds of funds can use exchange-traded indexes to adjust their allocation without making a long-term commitment. “Funds of funds may use such products to maintain exposure to the marketplace while preserving liquidity in the portfolio to manage cash flows,” Mr. Midgen said.

There clearly are regulatory and market barriers to the development of readily tradable hedge fund pools. If and how they will be overcome is still to be seen.

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