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Capturing hedge fund risk factor exposures: Hedge fund return replication with ETFs

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  • Jun Duanmu
  • Yongjia Li
  • Alexey Malakhov

Abstract

We develop a new factor selection methodology of spanning the space of hedge fund risk factors with all available exchange traded funds (ETFs). We demonstrate the efficacy of the methodology with out‐of‐sample individual hedge fund return replication by ETF clone portfolios. This is consistent with our interpretation of ETF returns as proxies to risk factors driving hedge fund returns. We further consider portfolios of “cloneable” and “noncloneable” hedge funds, defined as top and bottom in‐sample R2 matches, and demonstrate that our ETF clone portfolios slightly outperform cloneable hedge funds out of sample.

Suggested Citation

  • Jun Duanmu & Yongjia Li & Alexey Malakhov, 2020. "Capturing hedge fund risk factor exposures: Hedge fund return replication with ETFs," The Financial Review, Eastern Finance Association, vol. 55(3), pages 405-431, August.
    • Handle: RePEc:bla:finrev:v:55:y:2020:i:3:p:405-431
    DOI: 10.1111/fire.12221
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    Cited by:

    1. Auer, Benjamin R. & Schuhmacher, Frank & Niemann, Sebastian, 2023. "Cloning mutual fund returns," The Quarterly Review of Economics and Finance, Elsevier, vol. 90(C), pages 31-37.
    2. Adam L. Aiken & D. Eli Sherrill & Kate Upton, 2022. "Side‐by‐side management of mutual funds and actively managed exchange traded funds," The Financial Review, Eastern Finance Association, vol. 57(3), pages 533-557, August.

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