I’m here to defend hedge funds. Well … okay, I’m not defending them outright. You can’t really defend their insanely high fees and perceived terrible performance. But the concept of a hedge fund is sound.
The problem lies during the go-go dotcom days when many hedge funds were based on trading, trading and more trading. They managed to rack-up some pretty crazy returns. Suddenly to the investing public & media, “hedge fund” became synonymous with 20%, 30% or 50% annual total returns.
Historically, though, those kinds of returns aren’t what hedge funds are about.
Hedge funds are just that: “hedged investment funds.” They are really designed to be absolute return elements — proving consistent gains in all sorts of market environments without the volatility associated with the stock market. The key is consistency, which doesn’t necessarily mean beating the market.
Most hedge funds are good about providing consistency. The problem is that high fee hurdle.
However, three new exchange-traded funds (ETFs) from Highland Capital maybe of interest to investors. These, along with several other alternatives ETFs, provide much of the hedge fund bang without spending all the bucks.
Why Hedge Fund ETFs?
The big problem for investors is that asset classes are all getting more and more correlated. It used to be easy to diversify a portfolio. If you owned U.S. stocks, buying some international ones or bonds was enough to keep you protected.
However, as the world’s economies have gotten closer and closer together, so have different asset classes.
Consider this: Research by fund manager Direxion shows that between 1994 and the end of 2013, both developed and emerging international stocks had a correlation of 80% and 72% with the S&P 500. Those numbers mean they are moving almost in lock-step with the S&P 500.
Even the benchmark bond index — the Barclays Capital U.S. Aggregate Index– showed a positive correlation with stocks during that time. Bonds, you may remember, are supposed to move opposite stocks.
In other words: You may not be as protected as you think you are.
Strategies such as long/short, event-driven and merger arbitrage, as well as asset classes like commodities, currencies and managed futures still offer low correlations to stocks and bonds. All of these non-correlated things are typical hedge fund fare. And while the investment’s strategies at first blush may seem complex, the basic principal is to find a way to generate consistent returns — without the volatility associated with the stock market.
The beauty of using an ETF is that the fees for owning these alternatives and hedge funds is reduced to the low costs that we’ve grown to love and enjoy.
Highland’s New Hedge Fund ETFs
Building on its success with the $321 million Highland/iBoxx Senior Loan ETF (SNLN), Highland Capital recently unveiled three new hedge fund ETFs that seek to track various strategies employed by funds. The Highland HFR Global ETF (HHFR), Highland HFR Event Driven ETF (DRVN) and the Highland HFR Equity Hedge ETF (HHDG) were all created in partnership with Hedge Fund Research Inc. — often abbreviated to HFR — which is the leading research and index provider in the sector.
That HFR partnership means that these ETFs are actually index funds tracking various hedge fund strategies and not hedge funds themselves
The HFR Global ETF, HHFR, will track the HFRL Global Index, which will hold stocks, bonds and other assets. The fund looks to replicate event-driven, long/short equity, macro, relative value and other strategies commonly used by hedge fund managers. HHFR is kind of the catch-all for the entire hedge fund universe.
The HFR Equity Hedge ETF, HHDG, will track an index of hedge fund equity holdings that use quantitative and fundamental techniques. HHDG should look like a more “trading-style” fund.
And The HFR Event Driven ETF, DRVN, will track the HFRL Event Driven Index — which looks to “take advantage of transaction announcements and other specific one-time events.” These can include M&A, restructurings, tender offers, buybacks, debt exchanges or other capital structure adjustments.
Each of the new hedge fund ETFs from Highland will all charge 0.85% — or $85 per $10,000 invested. And while that’s more than a bread-and-butter S&P 500 index ETF, that’s downright cheap compared to the high cost of owning a real hedge fund.
For investors, the trio of funds — especially catch-all HHFR — can be useful diversifiers. Some experts recommend placing as much as 20% of your portfolio in “alts”. However, adding just a 5% weighting is enough to lower volatility. The Highland trio makes an easy and relatively inexpensive way to add that small weighting.
Just remember, these things aren’t going to “knock it out of the park.” They’re not supposed to. The idea is to generate consistent, positive total returns over various market cycles. And that’s what the indices that the funds are based have done over the last few years.
The Bottom Line: Hedge funds get a bad rap due to their high fees. However, hedge fund ETFs still allow investors to benefit from the asset class without the hefty costs.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
