A hedge fund manager who lowers his or her fees to switch from a hedge fund to an ETF status may have to more than double assets under management to earn the same amount of fees.

"It's often the managers who are less well-known or struggling to attract assets," said John Shearman, chief executive officer at California-based IV Lions LLC and a longtime hedge fund consultant. "Some of these managers are trying to grow their business but struggling to compete in a hedge fund market that's increasingly dominated by larger funds," and so they move to the mutual fund or ETF market.

Alternative And Active Growth

Growth in alternative and actively managed ETFs is also paving the way for hedge funds to make the transition. As of the end of December, there were 221 alternative ETFs with $11.6 billion in assets, up 28.2 percent in one year alone, according to data from State Street Global Advisors. Alternative ETFs include hedge-like strategies such as merger arbitrage, long/short and volatility plays.

Actively managed ETFs, which also include some alternative strategies, also had a robust year in 2013, with 20 new fund launches, the largest annual count in the past six years, according to data from San Francisco-based ETF.com.

"It's only logical that existing hedge funds would try to move into that space," said John Rekenthaler, vice president of research at Chicago-based Morningstar. "I'm surprised we haven't seen more of that given how much money and attention is flowing into registered funds, ETFs and mutual funds offering alternative strategies."

Democratization

Mark Yusko, chief executive officer at Chapel Hill, N.C.-based Morgan Creek Capital Management LLC, who manages funds of hedge funds only available to qualified investors, sees the ETF space as ripe for his kind of approach.

"There are so many good strategies that the average person just can't get exposure to if they're not a qualified purchaser or a qualified client," said Yusko.

Yusko said he has been in talks with ETF firms about creating an ETF that would mimic some of his hedge-like strategies. The active ETF would include traditional investments in stocks, bonds and cash, as well as some hedging strategies such as arbitrage, the concurrent buying and selling of securities to take advantage of price differences, or long/short investing, which involves hedging securities purchases with simultaneous sales of borrowed similar securities.