Harry Kat, a professor at London’s Cass Business School,
developed the third common strategy, which is just becoming commercialized.
Kat’s method differs from the other two in that rather than trying to replicate
hedge fund returns in a vacuum, he takes an investor’s existing portfolio (with
stocks, bonds, cash, etc.) and then, using liquid instruments, creates a segment
that statistically looks like an allocation to hedge funds. Simply by using
futures, regular equities and bonds, and other liquid instruments, he creates a
product structure that gives the returns of hedge funds but is not correlated
with the rest of the investor’s portfolio.
In other words, he tries to harness the diversification
benefits of hedge fund returns (which are not linked to the broad performance of
the financial markets as the rest of the portfolio is). As Worth went to press, he had just signed a licensing agreement with the
investment company New Wave Asset Management, which plans to launch a commercial
version of Kat’s service called FundCreator.
Not surprisingly, Kat is no fan of the competition’s methods. "Hedge funds by their very nature are extremely dynamic, and you can’t capture
that with one of these factor models," he says. Any performance benefits an
individual manager might have—the raison d’être of hedge funds—are diversified
away, leaving just normal market returns, he argues. "The HFRI composite index
is highly correlated with the S&P 500. Are you as an investor interested in
something like that?" Not if you want absolute returns, he says. From Kat’s
point of view, the factor-based products that banks offer are just packaging up
the same kind of returns everyone already gets through their traditional
investments.
Kat’s competitors obviously disagree, and claim they offer
alternative returns at small cost and in a transparent way. Who’s right? Maybe
both are, but at this stage, nobody is sure. Hedge fund clones are brand new
and—at least for the time being—unproven.
John Ferry is an Edinburgh, Scotland–based financial writer and a
senior correspondent for Worth.
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