Synthetic hedge funds

• Author: Matthias X. Hanauer,Robert Heigermoser,Mario Fischer
• DOI: http://doi.org/10.1016/j.rfe.2016.02.002
• Published date: 01 April 2016
• Date: 01 April 2016

Synthetic hedge funds☆

Mario Fischer

a,b,

⁎,MatthiasX.Hanauer

a,c

, Robert Heigermoser

a,d

a

Departmentof Financial Managementand Capital Markets,TUM School of Management,Technische UniversitätMünchen, Arcisstr.21, 80333 Munich, Germany

b

Yale Schoolof Management, YaleUniversity, 165 WhitneyAvenue, 06511 New Haven,United States

c

InvestmentResearch, RobecoAsset Management, Coolsingel120, 3011 Rotterdam,The Netherlands

d

Wealthand Asset Management, EY,Arnulfstr. 59, 80636 Munich,Germany

abstractarticle info

Availableonline 22 February 2016

JEL classification:

G11

G12

G23

We provide evidence on theperformance and the replication success of a broad sample of 72 synthetichedge

funds from January 2009 to December 2013. Thereby, we assign the term “synthetic he dge fund”to mutual

fundsand exchange-traded fundswith hedge fund indices as theirbenchmarks. Replicationsuccess is measured

throughdifferent perspectivesfrom distributionalcharacteristicsto risk-adjustedperformance. We findan over-

all significant underperformanceof synthetic hedge funds compared to an appropriatebenchmark index. Fur-

thermore, mutual funds (a ssociated with active portfolio management) can produce return charact eristics

closer to hedge fund benchmark s than exchange-traded funds (associated with passi ve management) can.

From a single strategyperspective, we find a picture of heterogeneity. Regardingthe market environment, we

show largerreturn differences for unusualmarket conditionsthan for regular ones.

© 2016 ElsevierInc. All rights reserved.

Keywords:

Clone

Hedge fund

Indexing

Replication

1. Introduction

In recent years, financial markets have experienced a series of un-

precedentedcrises: a liquidity crunch that seriously affectedthe inter-

bank lending market, a burst of the US housing bubble, and the

subsequentbanking and sovereign debtcrisis. This series of eventshas

led to a global economic downturn while the consequences are still

felt today. With the drop of global bas e rates to a historical trough,

many investorshave to cope with negativereal interest rates.This spe-

cifically affects institutiona l investors such as endowments, pension

funds, and insurance companies , which are typically committe d to

long-term agreements that have been entered at timeswhen interest

rates were on higher levels. Consequently, institutional investors are

searchingfor alternatives to traditional investmentsin order to achieve

thereturns needed to fulfilltheir obligations.Hedge fundshave received

noticeablyincreased attentionin recent years. Thisincreased interestof

institutionalinvestors reveals a significantgap between characteristics

of hedgefunds and institutionalinvestors' expectations. Institutional in-

vestors typicallyhave high transparency requirementsand impose re-

strictions on their investment ma ndates, as they are bound to strict

regulatorystandards.It is moreover usual that theyrequire a certain de-

gree of liquidity to meet thei r contractual obligations. O n the other

hand, the hedgefund industry is marketedas an absolute return indus-

try where returns depend on manager skills. Therefore, it is common

that hedge fund managersdo not provide position-level transparency,

have limited capacity, and resist any rest rictions in their investment

process. This behavior is back ed by the argument that any kind of

restrictioncuts down performance.In addition, hedgefunds charge rel-

atively high management fees compared to traditional mutual fun ds

and commonlyrequire lock-up periods.

Since it is apparent that expectations of both parties –institutional

investors and hedge funds –are incompatible, ideas to obtain returns

similar to hedge funds without directly investing in those funds have

been brought up. Those concepts are com bined under the terms

“hedge fund replication,”“hedge fund clones,”“hedge fund tracking,”

or simply “synthetic hedge funds.”Repl icating the returns of hedge

funds has gatheredsignificant academic andpractitioner interest since

the beginningof the century. As a first step, it wasnecessary for acade-

mia to substantiate the claim that hedge fund returns are not entirely

driven by managerskill.

1

After the theoretical frameworkhad been in-

vestigated,the developmentof two different hedgefund replication ap-

proachescould be observed: a factor-basedapproach which uses linear

factormodels of investableassets to modelthe time series of hedgefund

returns and a payoff distribution a pproach which models the

Reviewof Financial Economics 29 (2016)12–22

☆We thank BradfordJordan (guest editor), ChristophKaserer, Tarun Mukherjee (edi-

tor), FriedrichOsterhoff, Maximilian Overkott,and Andrea Schiralli. Additionally,we ac-

knowledgethe valuable commentsof two anonymous reviewers.

⁎Correspondingauthor at: Departmentof Financial Managementand Capital Markets,

TUM School of Management, Technische U niversität München, Arc isstr. 21, 80333

Munich,Germany.

E-mailaddresses: mario.fischer@yale.edu(M. Fischer ), matthias.hanauer@tum.de

(M.X.Hanauer), robert.heigermoser@tum.de(R . Heigermoser).

1

For example, Agarwaland Naik (2004),Fungand Hsieh (2001, 2004, 2011)and Jaeger

andWagner (2005) show howhedge fund returnscan be sufficientlymodeled with expo-

suresto systematic risk factors.

http://dx.doi.org/10.1016/j.rfe.2016.02.002

1058-3300/©2016 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe