Are investment products linked to hedge fund performance indices a quick and painless way to get market-beating returns? Banks, brokers, and private wealth managers have been pitching these products—structured as mutual funds, notes, or managed accounts—for a little more than a year, but still no easy answer awaits the question. Though these products charge far lower fees than hedge funds or even funds of funds, you must take careful note of how both the indices and the products linked to them are constructed.
 For decades, investors seeking broad stock market exposure have obtained it by employing futures and options on indices and, more recently, with exchange-traded funds. Index products such as these have historically outperformed many star-name fund managers. Similar products have since become available for fixed income and other markets. Cost effective, easy to buy, and liquid, these now number among the main weapons in any retail investor’s arsenal.
Alternative investments such as hedge funds have, until recently, resisted indexation. Unlike stocks or bonds, they are not liquid, tradeable assets with easy-to-find prices. Hedge funds come and go rapidly, are extremely secretive, and their portfolios change as fast as their managers’ market views. What funds to include in an index, how to weight them, and when to pull them out are questions fiercely debated among those institutions—Standard & Poor’s, Credit Suisse First Boston Tremont, and Van Hedge Fund Advisors among them—that publish hedge fund indexes and investable versions of those indices.
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