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| Risk & Reward |
An Alternate Route Through the Hedge Fund Maze
Laurence Neville
12/01/2003
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S&P takes a different approach: It gives equal weight to the nine investment styles in its investable index, arguing that this "avoids overrepresentation of currently popular strategies." Investors need to decide for themselves which approach makes sense. Those who want to let the market decide how their assets are allocated—for example, if everyone likes emerging markets this month, the index will become more heavily weighted with emerging-market hedge funds—should prefer CSFB Tremont’s approach. Those who want a steady allocation among different investing styles, despite the fact that it will keep them equally exposed to both popular and unpopular styles, might prefer S&P’s approach.
MAN OR MACHINE?
Should the choice of funds included
in an index be left to an expert’s
judgment or be based on strict rules, implemented objectively? It depends: How much do you trust the expert’s judgment? How well written
are the rules? |
"The aim for [our] product is to be as clearly defined as an [exchange traded fund] on the Nasdaq," Schupp says. "This is not like some index-based products, which have an index committee that makes subjective decisions." But one of CSFB Tremont’s biggest competitors—S&P—selects its hedge funds by committee. Where CSFB Tremont considers a fund’s size (after minimum disclosure and liquidity requirements are met) the key factor, S&P’s index committee attempts to identify managers who best represent their investment style, that is, who don’t drift from one style to another. Critics say this approach means the index is essentially a fund of funds, but without the active management offered by those investments.
Critics such as Webster University’s Schmidt also worry that only the biggest—and least nimble—funds can absorb the type of inflows these index products require. Size and strength do not necessarily equate: Larger funds can be more stable and professionally run, but they may prove too unwieldy to exploit market opportunities, and so risk underperforming smaller competitors. George Shinn, vice president, operations at TraderSource, a Portland, Ore.-based firm that offers alternative investment advice, explains, "Typically the best performance comes from younger, more nimble funds. Once a fund gets to a certain size, it becomes difficult to maintain the same returns."
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