Wednesday, March 28, 2012

Hedge Fund ETFs Coming For Stupid People

Non-accredited investors will son be able to throw money away in the same manner as high net worth investors.  Hedge fund ETFs that mimic some value and activist strategies will soon be here.  I shouldn't have to say that this is beyond stupid but I enjoy hearing myself think out loud.  This blog is all about public service.

The incompatibility of hedge fund strategies and ETF strategies is plain.  Classic ETFs mimic broad indexes as closely as possible, with a lot of constancy in their holdings and little turnover.  Hedge funds can mimic any strategy in the blink of an eye, where holdings turnover rapidly and incur unpredictable tax events.  ETFs are cheap because they seldom change their makeup.  Hedge funds are expensive because they change what they hold a million times a day.  Changes in ETF holdings lag changes in their representative indexes by no more than a day or two.  Changes in hedge fund ETFs, according to the filing documents themselves, can lag the representative hedge strategy's 13F filing by as much as 45 days.  That giant lag alone makes a copycat strategy meaningless.

Investors who think that buying a hedge fund will give them outsize returns need to subtract the two-and-twenty premium to calculate the impossibly large long-term alpha the fund will have to generate just to beat the tiny long-term beta of an ETF.  Investors who buy a hedge fund ETF will get the worst of all possible worlds.

Nota bene:  I don't buy hedge funds or ETFs based on hedge funds.