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3 Hedge Fund ETFs – Replicating Top Picks and Other Strategies

3 Hedge Fund ETFs – Replicating Top Picks and Other Strategies

With another pivotal quarter of earnings reports beginning to come across the wire, many investors are evaluating alternative investments in the event that benchmarks like the S&P 500 start to come under pressure. This is a smart practice, as investors should always be considering what steps they will - and won't - take given different events and outcomes in the markets.

Exchange-traded funds are increasingly offering investors access to alternative investments including the type of esoteric investment option earlier available to just the 1% crowd - hedge funds. I like to always keep up with new ETF offerings, especially those that offer unique investment theses and those based on novel tracking indexes. Today I'm looking at three funds that seek to replicate popular hedge fund strategies and top stock picks amongst hedge fund managers.

Fewer Hedge Fund Heroes Today

Many people hear glamorous hedge fund stories involving huge returns for investors - and the coinciding large paydays being earned by the fast traders and big egos at the helm. But the Great Recession wiped out a lot of the riskiest, no-speed limit funds. The majority of today's hedge fund industry is decidedly less sexy, designed around protecting downside risk in the portfolios of very large institutional investors. As a result of protecting against a rainy day, many hedge funds will lag behind equity indexes like the S&P 500 when the S&P is performing well. The hope is that these same funds will outperform and provide more stable returns when equity markets decline.

The hedge fund industry's performance stats through the first half of the year show us that 2014's strange mix of strong equities, slow GDP growth and continuing low yields has baffled even the sharpest market minds. According to analytics provider Barclay Hedge, the S&P 500 has more than doubled the average hedge fund return so far in 2014. And this follows an average 8.5% lower annual return by hedge funds going all the way back to 2009 when the recovery first began.

Investing in Global Merger Arbitrage

The IQ Merger Arbitrage ETF (NYSE Arca: MNA) follows the IQ Merger Arbitrage Index, which seeks to replicate the gains available in global equity arbitrage situations by investing in companies for which there are previously announced takeover offers. Some of the current largest holdings of the MNA are DIRECTV (NASDAQ: DTV), which is being acquired by Time Warner Cable (NYSE: TWC), and Covidien plc (NYSE: COV), which has an announced takeover offer from Medtronic (NYSE: MDT).

While I like the novel approach to the base index itself, I do not like the fact that the MNA tries to self-hedge its returns by investing in ultrashort (i.e. leveraged) funds.

Hedge Fund ETF IQ Merger Arbitrage ETF (NYSE Arca:MNA) Asset Classes

As it stands, the MNA has an attractive risk/return profile, showing a 3 year annualized volatility much lower than the S&P 500 at 9.54%. But I don't see the current market environment as one where there's a lot of money to be made betting on bidding wars between companies over takeover targets.

A Private Equity Basket Approach in the PSP

The PowerShares Global Listed Private Equity Portfolio (NYSE Arca:PSP) tracks the Red Rocks Global Listed Private Equity Index, which may comprise up to 75 companies engaged directly in private capital transactions or support private capital entities. The PSP has limitations on the amount of the fund that can be invested in higher-risk entities like foreign Business Development Corporations (BDCs) and investment companies.

I'm torn on this fund; I like the approach and feel that a fund like this could be an arrow in the quiver for some investors. The PSP pays a nice yield of above 2% and is well-diversified geographically. But I just can't endorse a passive investment with an expense ratio of 2.3%; it's an unconscionably high fee regardless of how geographically diverse the investments are.

Hedge Fund ETF PowerShares Global Listed Private Equity Portfolio (NYSE Arca:PSP)

GURU - Piggyback on Hedge Funds' Biggest Bets

The Global X Top Guru Holdings Index ETF (NYSE Arca:GURU) seeks to capture the price performance of stocks that are being actively acquired as long assets by a pre-selected group of hedge funds having more than $100 million in assets. The tracking index is the Solactive Guru Index, which uses a novel approach of reviewing the 13F reports of major hedge funds each quarter to see which stocks are being the most added to portfolios.

GURU has a reasonable (although still high) expense ratio of 0.75%, a strong asset base of $500 million, and a diversified portfolio of 58 holdings. It has handily outperformed the S&P 500 since its inception two years ago, and the Solactive Index seeks out those stock holdings most likely to represent long-term bets by hedge funds, not just short-term trades by high-turnover funds. As a result, I'd say GURU does a pretty good job of aggregating the stock picks held with the most conviction by high-profile hedge funds. GURU also has sufficient sector diversification for investors to consider swapping in a little slice for their existing S&P 500 or broad market equity holdings.

Hedge Fund ETF Global X Top Guru Holdings Index ETF (NYSE Arca:GURU) Asset Allocation Chart

The views and opinions expressed above are those of the author and do not necessarily reflect the views of, AnalytixInsight, Inc., its affiliates, or its employees.


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