The Disappointment of Hedge Fund ETFs

Hedge Fund ETFs continue to disappoint investors, but allocation remains on the increase.
(March 26, 2014) — Investors allocating to ETFs that track hedge fund strategies have reported another disappointing year, data from academics at EDHEC has found.

Less than 35% of users of this class of ETF reported they were satisfied with its performance in 2013. This level of satisfaction had already dropped over 2012 to 40% from a record high—for this asset class—of 65% in 2011.

In comparison, users of equity-bases ETFs have reported a 90% or higher satisfaction level since EDHEC began issuing its ETF Survey in 2006. By the end of 2013, these equity ETF users reported a 98% satisfaction level.

“These investment products enable investors to gain simple access to alternative investment opportunities such as hedge funds, commodities, real estate, or infrastructure,” the EDHEC report explained. “ETFs on alternative asset classes allow investors to diversify portfolios but do not require the infrastructure needed for direct investments and manager selection in alternative asset classes, infrastructure they may be unfamiliar with.”

The pull of these investment tools are clear, and investors have increased their allocation them rapidly, EDHEC said. In 2006, less than 10% of investors reported using hedge fund ETFs; in 2013, around 41% said they had an allocation to them. This is also due to a proliferation of new products, EDHEC said, adding that what attracted investors to the product may also be the cause of their frustration.

“ETFs in the alternative investment universe must deal with illiquid underlying assets, an obligation at odds with one of the main objectives of ETFs, that is, to provide high liquidity,” the report continued. “As a result, ETFs must usually rely on liquid proxies of the asset class that can only approximate the price movements in these asset classes.”

Hedge fund ETFs can rely on hedge fund factor models that make it possible to replicate the performance of broad hedge fund indices by investing in more standard and thus more liquid assets. To ensure the liquidity of the ETFs, only hedge fund managers who are active in strategies known for their liquidity are selected, EDHEC said.

For real life hedge funds, 2013 was a positive year, but as a group the strategies failed to outperform the S&P 500. Hedge funds recorded their best performance in three years in 2013, largely due to the strong equity market, ending the year with a 9.2% return, data firm eVestment found. In contrast, the S&P 500 rose more than 26%.

Investors reported only sustainable, responsible investment-based ETFs were more disappointing in 2013.

To read the full report, produced in association with Amundi, click here.

Related content: Hedge Funds Record 9.2% Return in 2013 & The ETF Atlantic Divide