Fees and Cloning

Replication products attempt to offer investors some of the advantages of hedge funds while avoiding their high fees, illiquidity, and opacity. Hedge fund managers test whether a replication algorithm can deliver the diversification and high Sharpe ratio that investors seek.

The procedure constructs monthly clone returns out-of-sample using fully collateralized futures positions held for one-month, with position sizes determined using rolling window regressions. Clone returns have high correlation with their hedge fund targets, indicating replication is possible. Clones also have high correlation with a buy-and-hold investment in stocks, however, and neither the targets nor their clones demonstrate successful time variation in factor loadings.

After conducting research, it can be seen that the clone portfolios, on the whole, are highly correlated with their underlying indices, their Sharpe ratios are generally inferior to those of the hedge fund indexes and annual returns are often below those of the indexes.

Clones can add value by capturing the factor timing activity of the hedge funds they are attempting to replicate.

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