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September 20, 2021 01:00 AM

Investable Hedge Fund Indices Offer Promise Amidst Peril

By P&I Content Solutions
This content was paid for by an advertiser and created in collaboration with P&I Content Solutions.
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    Darren Wolf
    Global Head of Investments
    Alternative Investment Strategies
    abrdn

    What can be said with certainty is that the world has not, in recent years, been faced with so much instability across so many different domains: global health, trade and, most recently, geo-politics, said Darren Wolf, global head of investments for alternative investment strategies at abrdn. “This backdrop typically has led to strong performance for hedge funds on the back of high volatility and significant dispersion across markets.”

    Yet as more institutional investors turn to alternatives such as hedge funds, they remain wary for a good reason. “The cost of getting your manager selection wrong is more severe in these types of environments,” Wolf said. “The risk of getting the overall bet right and the execution wrong can be pretty painful.”

    That’s where investable hedge-fund indices come in, that provide passive index exposure to hedge funds but without the execution risk.

    “Investable hedge-fund indices are very similar to passive equity investing in some ways, but very different in others,” Wolf said. In the case of equities, holding the benchmark delivers passive beta returns and, by definition, it means completely giving up on alpha or outperformance. Hedge-fund benchmarks, in contrast, offer the additional promise of alpha, he noted, as well as diversification and elimination of the selection risk of investing in a single manager. “Passive investing in hedge funds offers very similar benefits to passive equity investing, but with the additional prospect of generating alpha.”

    Avoiding the limitations

    For investors looking for passive exposure, hedge fund indices have typically been “un-investable,” unlike equity indices where it is easy to buy a basket of securities that make up the index, Wolf explained.

    “Hedge funds aren’t a single asset class that shares common risk factors. They’re trading strategies,” Wolf said. They include a range of strategies such as global macro, event-driven, or fixed-income arbitrage funds, each of which have nothing in common except perhaps their regulatory status and the words ‘hedge fund’ in their name. They are hard to access — some are closed to new investors, others are very small and still others are highly illiquid, he said.

    Investors and providers sold on the idea of a passive approach to hedge funds have tried get around these challenges through what are known as replication strategies, Wolf said. “Traditional replication strategies involve identifying ‘factors’ that represent hedge-fund returns to try to generate a return stream. It’s more of a synthetic way to attain passive hedge fund exposure,” he noted. However, many hedge-fund returns aren’t explained by risk factors and are not captured by these strategies, and the strategies don’t precisely track many benchmarks and could underperform them since they don’t directly invest in hedge funds.

    SPONSORED CONTENT BY:

    abrdn_Logo

    abrdn
    1900 Market Street, Suite 200
    Philadelphia, PA 19103
    Eric Roberts, Head of Institutional Business Development, US
    [email protected]
    (617) 720-7964
    abrdn.com

    Investing directly in the index

    However, investable hedge fund indices have been a game changer as the investor can actually invest in the index itself, rather than trying to synthetically recreate it. “Investors can adopt the investable indices as benchmarks with the knowledge that they can replace their existing hedge fund allocations with that benchmark. [That] has been a massive innovation for the hedge fund industry.”

    With an investable index, the provider replicates the underlying benchmark by actually investing in all of the underlying constituent managers, Wolf explained. Taking this approach requires screening out the hedge-fund managers that are closed, too small, too illiquid or otherwise un-investable. That screening process allows for the investments in the ‘investable’ underlying hedge funds.

    For its investable hedge-fund index offerings, abrdn has an exclusive partnership with HFR, a global leader in hedge-fund benchmarking, Wolf said. HFR creates and produces the benchmarks and provides the underlying constituent weights to abrdn. HFR also rebalances the indices in line with the constituent-fund liquidity terms. As the benchmark itself is investable, that means that abrdn can replicate it easily with minimal tracking error.

    CONTINUED READING

    Investing passively in an active asset class

    Keeping hedge funds on track

    “[Investable hedge-fund indices] may be the first time that investors can actually access passive investing in hedge funds. Before, there wasn’t really a way to get passive exposure that’s anchored to a real hedge-fund benchmark,” Wolf said.

    Investable indices to consider

    As institutional investors have different overall investment objectives, they seek to meet different return and risk goals through particular hedge fund sectors or strategies. abrdn offers a range of HFR strategy-specific benchmarks that allow investors to express their different points of view, Wolf said. “You can have a positive view on macro strategies, but you may not be sure which macro manager is going to outperform. So, you can invest in a fund on the ASI HFRI Index Tracking Platform that passively gives you macro exposure.” As with other similar investable indices, the advantage of this passive approach is that it offers investors diversified exposure without single manager risk. It also offers the ability to execute an allocation more quickly, by avoiding the time needed for due diligence to source and select an individual manager, he pointed out.

    What are some hedge fund sectors that institutional investors should consider today? “The shutdown of the global economy at the beginning of 2020 was such a severe shock to the system that it left no asset class untouched. [But] that means there are a number of good [opportunities] that we can look at,” Wolf said. abrdn has a favorable view on stock-picking hedge funds, and also for global macro managers that have a wide remit and can go long and short across asset classes.

    While clients may express a preference for an active or passive allocation to hedge funds, overall, it is a timely asset class given the overall macro environment, said Wolf, noting that abrdn has a very large active hedge fund selection business based on bottom-up manager research. “When things are more volatile, uncertain and potentially declining, that’s when the diversifying properties of hedge funds really come to fruition.”

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    “The appeal of hedge funds is very high right now. And for that reason, it’s important to have hedge funds as a permanent piece of a broader asset allocation,” Wolf said. Investable hedge fund indices represent a way to get the most diversified exposure, while not giving up the possibility of some alpha. “You get the average alpha of hundreds of underlying hedge funds.”■

    This sponsored content is published by the P&I Content Solutions Group, a division of Pensions & Investments. The content was not produced by the editors of Pensions & Investments and www.pionline.com and does not represent the views of the publication or its parent company, Crain Communications Inc.

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    December 12, 2022 page one

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