By SARAH MORGAN
Getting the sophisticated strategies> of a hedge fund in the low-fee structure of an ETF may sound like a sweet deal for regular investors, but a handful of so-called hedge-fund ETFs launched more than a year ago have so far been serious busts.
Compared to the broad market, all four hedge-fund ETFs launched in 2009 have underperformed and by quite a lot. Since its inception in March 2009, the Multi-Strategy fund (QAI)
Of course, investing experts argue that hedge funds aren't always out to generate outsized returns; in fact, they're main job is to limit risk by balancing long bets with short bets and provide returns that aren't correlated with those of the broad stock market, says Adam Patti, the CEO of IndexIQ. "Many investors are under the misconception that hedge funds are designed to shoot the lights out," says Patti. Investors instead should expect alternative strategies to underperform in a strong bull market for stocks, says Jeff Tjornehoj, head of Lipper Americas Research. Underperformance in good times should be balanced by outperformance in down markets, says Nadia Papagiannis, an analyst at Morningstar. Case in point: The Morningstar 1000 Hedge Fund Index has fully recovered from the 2007-2009 market downturn, while investors in market-neutral funds are still recovering from those losses, she says.
Even so, these ETFs are also mostly lagging their benchmarks. For example, the IndexIQ Multi-Strategy fund returned 9.2% from April 2009 through the end of 2010, while the Morningstar 1000 Hedge Fund Index rose 17.2%. The iShares Diversified Alternatives Trust edged up 0.66% from November 2009 through the end of 2010, while Morningstar's Global Non-Trend index, which tracks traditional global macro strategies, climbed 3.06%. The IndexIQ Merger Arbitrage fund lost 1.28% from December 2009 through the end of 2010, while Morningstar's Corporate Actions hedge fund index gained 16.85%. Only the IndexIQ Macro Tracker fund beat its benchmark, the Global Non-Trend index, from July 2009 to the end of 2010, rising 9.5% while the index rose 5.5%. Patti points out that the gains for the hedge-fund indexes are pre-tax returns, and so appear higher than the real returns of the hedge-fund ETFs.
The bottom line for investors seeking eye-popping returns in a strong market for stocks: Look elsewhere. The very qualities that make these funds appealing in a bear market turn them into laggards when stocks rise, experts say. The three IndexIQ products track the performance of all hedge funds, or all hedge funds with a given strategy, then analyze those returns to determine what assets the ETFs should hold. In other words, they generate an estimate for the expected return of an average hedge fund and then use a quantitative model to come up with investments that will recreate that return, says Victor Leong, a hedge fund analyst for Wedbush Securities.
Regardless of their recent performance, experts say these funds do live up to part of their original allure promise--offering regular investors easy access to alternative strategies typically reserved for the ultra-wealthy in funds that can be traded daily unlike hedge funds, which tend to require long lock-up periods. Another key selling point, says Papagiannis, is that these funds are much cheaper than hedge funds. Of course, their costs are still higher than many other index-based ETFs. The IndexIQ Multi-Strategy and Macro Tracker ETFs charge 1.13%, while the Merger Arbitrage ETF charges 0.77% and the iShares Diversified Alternatives Trust charges 0.95%. The popular SPDR S&P 500 ETF (SPY)