Hedge funds used to be the man. According to a Wall Street Journal analysis of data from hedge fund industry research company HFR Inc., hedge funds employing various equity strategies beat the total returns on the S&P 500 Index by an annual average of more than five percentage points between 1990 and 2009. Since then, such funds on average have trailed the index by almost 9 percentage points annually.

Not surprisingly, wealthy investors and institutional investors who generally pay full freight (i.e., the traditional “2 and 20” fee structure) are jumping ship. According to HFR, hedge funds that rely on stock picking have suffered three consecutive years of net outflows, which is the longest streak of its kind in HFR’s nearly 30 years of data tracking.

But even as investors seem to be souring on traditional hedge funds, or at least on the equity side, they still want a piece of hedge fund-like strategies contained in (much) lower-cost liquid alternative exchange-traded funds. In a recent report, Greenwich Associates forecasts that institutional investments in liquid alternative ETFs will more than double in the next 12 months, to roughly $114 billion. Individual investors and financial advisors also are gravitating toward these funds to a degree in an attempt to diversify their portfolios, using hedge fund-like strategies that run the gamut from long/short and global macro to arbitrage and market neutral.

There are about 40 such ETFs on the market, but this article will focus on two products offering completely different ways to capture hedge funds in a liquid ETF. One is focused solely on generating alpha; the other is all about beta, or creating a hedge against downturns. We’ll start with the alpha-seeking fund.

AlphaClone Alternative Alpha ETF (ALFA)

This ETF tracks the AlphaClone Hedge Fund Masters Index, which invests in the high-conviction stock holdings disclosed by hedge fund managers with high alpha potential. The methodology was developed by Maz Jadallah, founder and CEO of AlphaClone, who says it is akin to “moneyball” for manager selection. Using mandated SEC holdings disclosures (Form 13F), AlphaClone simulates investing in a manager’s holdings and then assigns a Clone Score, or “batting average,” for each manager in their universe. Managers are scored twice a year and the 13F filings from the 10 managers with the highest scores are used to construct the index. The index equal weights the five largest holdings from each of the 10 managers and reconstitutes its holdings quarterly after the latest 13F filings are released.

“When it comes to active managers among hedge funds and mutual funds, the average—meaning an index of these managers—is always poor,” Jadallah says. “But the dispersion, or the difference between the best and worst performers in the index, is very high. So you can still have poor average performance but still have great performers in the index from the outliers. It pays to find the right manager.”

This is a long-only fund, but it wasn’t always that way. It formerly followed an index with a hedge component that could take the strategy from long-only to market neutral, but it ditched that in late December 2017 because, according to Jadallah, advisors weren’t sure where this fit into client portfolios. (As we’ll see below, the market-neutral approach also negatively impacted the fund’s performance.)

He notes the fund’s current iteration makes it a fit in the U.S. large-cap equity bucket.

“Our strategy seeks to be the growth engine inside your portfolio,” Jadallah says. “We don’t seek to replace the S&P 500; we seek to replace other growth-oriented active strategies. So the allocation can depend on how an advisor runs their money.”

The ALFA fund has an expense ratio of 0.69%.

IQ Hedge Multi-Strategy Tracker ETF (QAI)

The QAI fund follows an index seeking to track the returns of distinct hedge fund investment styles. Its goal is to capture the beta portion of returns, which is defined as the returns of hedge funds that are non-idiosyncratic, or unrelated to manager skill. The underlying IQ Hedge Multi-Strategy Index includes both long and short positions in ETFs and exchange-traded products.

As of early November, the fund’s portfolio of nearly 70 holdings was topped by a 17.7% weighting in the iShares Short Treasury Bond ETF (SHV). The list of top 10 holdings also included ETFs investing in Treasury bills, investment-grade bonds, floating-rate bonds, senior loans, international small-cap equities and a currency-hedged international equity fund.

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