Should you buy hedge-fund ETFs?

Beware of hedge-fund ETFs. They offer most of the costs of a hedge fund, with few of the advantages of exchange traded funds, says Paul Amery.

Exchange-traded funds (ETFs) and hedge funds don't have much in common. ETFs are cheap, and if you go for a plain vanilla FTSE or S&P 500 tracker, you know exactly what you're getting. Hedge funds, on the other hand, are both costly and secretive. So the idea of a hedge-fund ETF might strike the more cynical among you as being a marketing stunt, to capitalise on the growing popularity of ETFs. And we reckon you'd be right to be sceptical.

Hedge funds use a range of strategies, so grouping them under one umbrella is simplistic. But broadly, they aim to avoid market falls, while providing returns that are uncorrelated to other asset classes. Their success is open to question. The average fund lost 18% in 2008 better than most markets, but far worse than cash. More damagingly, lots of funds restricted redemptions and investors found themselves unable to pull out. Hedge-fund ETFs aim to beat this liquidity issue by ensuring all fund positions are held on a single platform. This allows daily redemptions and, in theory at least, close tracking of the underlying net asset value. But you won't learn any more about the underlying investment decisions than with a normal hedge fund.

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And there's the rub. It may say 'ETF' on the label, but you are just buying an actively managed fund, with hedge-fund fees to boot. These run to 1.75% a year, plus a 20% performance fee, in the MW Tops Global Alpha ETF, or 0.9% plus underlying hedge-fund fees (usually 1.5% plus a 15%-20% performance fee) in db x-trackers db Hedge Fund Index ETF. That compares to an average 0.15% a year for an ETF tracking Europe's most widely used equity index, the Euro Stoxx 50.

Whether you think it's worth paying all that extra for a fund manager's skill cuts to the heart of the 'active' versus 'passive' debate in fund management. Plenty of investors do db x-trackers db Hedge Fund Index ETF raised over $1bn in assets in its first year and more such funds are on the way. But we like ETFs precisely because they don't employ costly fund managers of dubious value, and because they give you an easy way to manage your asset allocation yourself. Sadly, hedge-fund ETFs seem to offer most of the costs of a hedge fund, with few of an ETF's key advantages.

Paul Amery is editor of www.indexuniverse.eu .