market folly

Sigh... when will it end? Exchange traded funds (ETFs) that try to imitate hedge funds are all the rage in the investment world these days. Previously, we've covered the release of QAI, a hedge fund ETF. We criticized that vehicle because it merely invested in other exchange traded funds and acted like a fund of funds rather than an individual hedge fund strategy. Then, more recently, we detailed the release of mutual funds using hedge fund strategies. In particular, we focused on the Turner Spectrum Fund which will pursue various long/short equity and market neutral strategies. This time around, a new firm has entered the hedge fund ETF arena.

WisdomTree is known for creating their fundamentally weighted ETFs, typically centered around dividends and profits. Now, however, they are turning to actively managed ETFs in an effort to expand their product line. And, they certainly have quite the consultant on board to help them do so. After all, hedge fund pioneer and legend Michael Steinhardt is WisdomTree's chairman. (We recently covered Steinhardt's thoughts on the markets here). So, we would like to assume/hope that Steinhardt had some say in the creation of these vehicles. But, who knows, as stupider things have happened in this world.

WisdomTree is rolling out three actively managed ETFs including a Real Return fund, a Managed Futures fund, and a Long-Short fund. The Real Return fund will play the inflation thesis by investing in TIPS, other fixed income securities, and commodities. This fund is specifically targeting to outperform the inflation rate going forwards. Their Managed Futures fund will be quantitative in nature and will invest in futures contracts, primarily in commodities. Lastly, the Long-Short fund will use pairs trades derived from their already existing ETF family and will run market neutral.

Overall, it sounds like they are taking a solid approach in their Managed Futures fund, as this could help give retail investors further opportunity to invest in the futures markets. Their Real Return fund will essentially just be a basket of inflation plays and off the cuff doesn't seem like anything particularly special. Lastly, the Long-Short fund is not as enticing to us because they are merely doing pairs trades with their pre-existing ETFs, something we could do on our own without paying the expense ratio. And, speaking of expenses, WisdomTree has yet to reveal the costs of each fund. The other thing to highlight here is that these will be actively managed ETFs, so the allocations of each fund will ultimately be up to the fund manager. And that is where things could get interesting, dependent upon how 'active' they actually are.

Overall though, vehicles like these have not entirely impressed us. Instead of investing in these newer and unproven products, we'd recommend taking a more direct approach and using Alphaclone to clone hedge fund portfolios directly based on equity positions the underlying hedge funds actually hold. After all, we did just that with our custom Market Folly portfolio and we've seen 19.8% annualized returns since mid-2002 and are even up 14.4% year-to-date for 2009. Or, if you want to take an even more do-it-yourself approach, we'd recommend reading Mebane Faber's book, The Ivy Portfolio, where he details how to invest like the top endowments and hedge funds. (Our review of the book here).

Its obvious that these ETFs aren't going anywhere and we're sure that even more are in the pipeline. Once we get enough datapoints to truly track their performance and correlation, we'll do a follow-up post on all the vehicles we've previously covered. On the bright side, at least we've found a new bull market: investment vehicle creation.