New York (hedgeCo.net) Liquid alternatives have been growing in popularity over the last decade. There are different types of liquid alternatives and some use cloning or replication techniques and those are the ones we will focus on at this time. These funds attempt to clone or replicate what hedge funds are doing, but they do this without working directly with the hedge funds. What they do is follow the public disclosures of hedge funds and then try to construct a similar portfolio based on what the records show. One problem with this strategy is that hedge funds don’t make their holdings public until they file their 13-F form at the end of each quarter.

As an example of how public disclosures work, if a hedge fund went in and sold a stock short on July 1, they are not required to disclose that short holding until the end of the third quarter which is three months away. Then there is a lag of another 45 days for funds to file their 13-F forms. So the public disclosure happens four and a half months after the positions was initiated. How effective do you think a cloning strategy would be in a choppy, volatile market? The stock sold short in the example above could be down 20% or up 20% over the course of that time.

Let’s look at a few stocks to see what can happen in four and a half months. Two segments of the market that have been under pressure in the last four and half months are Chinese stocks and basic materials stocks, so let’s look at a stock from each of these segments to see what they did in the four and half months from mid-March through the end of July. For Chinese stocks Baidu was selected and for the basic materials sector Alcoa was selected. In the time period in question, Baidu dropped 15.9% and was down over 18% at its low point. Alcoa dropped 25.57% during this same time period and was down over 27% at its low.
How would you feel if you were invested in a cloning ETF or platform and they are now executing short sales on Baidu and Alcoa after they have dropped like they have? How do we know if the hedge funds are still short these stocks? The hedge funds may have bought the shares back between the end of the quarter and the deadline for filing their 13-F form.

Liquid alternatives that use cloning techniques will always be making trades weeks and months after the hedge funds have. We all know how fast the market can move at times and thus the reason the HedgeCoVest platform is a more realistic way to emulate the holdings of hedge funds. When a hedge fund manager on our platform executes a trade, if you are following that manager’s model, a best effort will be made to make the same trade with the same weighting in your account within seconds. Which methodology do you think is going to come closer to replicating the trades and the performance of the underlying hedge funds, one that acts weeks or months after the fact or the one that acts within seconds?

Another issue with following 13-F filings to try to copy what hedge funds are doing comes from intra-quarter trades. The filings only require disclosing current holdings. If a hedge fund moves in and out of a stock within the quarter, it won’t show up on the 13-F form and the liquid alts that are trying to emulate that portfolio wouldn’t even see that trade.

HedgeCoVest models follow the trades of professional hedge fund managers and immediately make the same trades for investors. We aren’t waiting as long as four and half months to clone a trade and we are privy to the intra-quarter trades the funds make. This is why we feel that our platform provides a truer depiction of what hedge funds are doing than other platforms, mutual funds or ETFs.

Rick Pendergraft
Research Analyst
HedgeCoVest