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Hedge fund replication strategies: implications for investors and regulators

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  • Fung, W.
  • Hsieh, D A.

Abstract

Over the past decade, academic research has identified a number of replication strategies capable of capturing between 40% to 80% of the average return of many popular hedge fund strategies. Investors are beginning to take notice of these replication strategies, especially because of their rule based, transparent features and the fact that they can be executed at low cost. Armed with this alternative way of accessing passive hedge fund returns, investors can effectively structure incentive fee contracts to reward skill-based returns (i.e., alternative alpha) differently from passive index-liked returns (i.e., alternative beta). This can raise the barrier to entry for new funds to the industry in that hedge fund managers must demonstrate skill in order to participate in profi t sharing. This should reduce the risk of herding by hedge fund managers who may otherwise be enticed by incentive fee contracts that rewards them for taking popular factor bets.

Suggested Citation

  • Fung, W. & Hsieh, D A., 2007. "Hedge fund replication strategies: implications for investors and regulators," Financial Stability Review, Banque de France, issue 10, pages 55-66, April.
    • Handle: RePEc:bfr:fisrev:2007:10:6
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    Cited by:

    1. Sam Nasypbek & Scheherazade S Rehman, 2011. "Explaining the returns of active currency managers," BIS Papers chapters, in: Bank for International Settlements (ed.), Portfolio and risk management for central banks and sovereign wealth funds, volume 58, pages 211-256, Bank for International Settlements.
    2. Sujit Subhash & David Enke, 2019. "Hedge fund replication using strategy specific factors," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 5(1), pages 1-19, December.
    3. Urbi Garay & Enrique Ter Horst & German Molina & Abel Rodriguez, 2016. "Bayesian Nonparametric Measurement of Factor Betas and Clustering with Application to Hedge Fund Returns," Econometrics, MDPI, vol. 4(1), pages 1-23, March.
    4. Savona, Roberto, 2014. "Hedge fund systemic risk signals," European Journal of Operational Research, Elsevier, vol. 236(1), pages 282-291.
    5. Roncalli, Thierry & Weisang, Guillaume, 2011. "Tracking Problems, Hedge Fund Replication, and Alternative Beta," Journal of Financial Transformation, Capco Institute, vol. 31, pages 19-29.
    6. El Kalak, Izidin & Azevedo, Alcino & Hudson, Robert, 2016. "Reviewing the hedge funds literature II: Hedge funds' returns and risk management characteristics," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 55-66.

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