Why Model Portfolio Managers May Embrace Replication of Hedge Funds
Model portfolios are built on the premise that asset allocation drives long term portfolio returns. Alternative strategies like hedge funds can provide diversification benefits that may improve long-term returns and reduce drawdowns. Unlike institutional portfolio, model portfolios for retail investors have several constraints: limited to mutual funds and/or ETFs, one or two funds per asset allocation category, and higher sensitivity to fees. These constraints drive allocations to lower cost index or index-like products across asset classes. In the alternative mutual fund and ETF space, however, most funds are expensive and are based on single manager strategies that can deviate meaningfully from the strategy benchmark or index. Replication of hedge funds – strategies designed to deliver the performance of a diversified basket of hedge funds by investing in the drivers of returns through liquid futures and/or ETFs – are designed to provide more diversified exposure at lower fees and expenses. Alternative mutual funds and ETFs that employ these strategies therefore are an attractive solution for model portfolios.
