Taking stock – AlphaClone Alternative Alpha Exchange-Traded Fund (ALFA)

Ulli Hedge Fund ETF Contact

The ETF industry already provides investment opportunities in hedge funds, which once were the exclusive domain of the ultra rich.

Well, the choice just got wider as Exchange-Traded Concepts announced the launch of AlphaClone Alternative Alpha Exchange-Traded Fund (ALFA), a fund that seeks to replicate the composition of the AlphaClone Hedge Fund Long/Short Index, a benchmark that tracks the publicly disclosed positions of the hedge funds and institutional investors.

The benchmark is comprised of holdings of managers with highest “Clone Scores”. A Clone Score is a proprietary gauge developed by AlphaClone that measures the effectiveness of following a manager based on their disclosed holdings and incorporates monthly returns in excess of the broad market index (alpha) and a fixed hurdle rate. The equity components are selected from hedge fund managers that have the highest rankings (Clone Scores), which they disclose through regular SEC filings.

The benchmark is expected to be equal-weighted, but may exhibit Overlap Bias if more than one hedge-fund manager holds the same security. A dynamic hedging mechanism allows a wide variety of strategies; from only long to market neutral, or up-to 50 percent exposure in inverse unleveraged funds. The fund’s portfolio follows three basic principles: 1) dynamic hedging, 2) position replication and 3) automatic re-balancing. The rules-based AlphaClone Index re-balances long positions quarterly and re-calculates clone scores semi-annually.

The back-tested performance of the dynamic hedging strategy from 2000 has been hugely successful, returning nearly 18 percent versus 0.55 percent and 0.82 percent annually for the S&P 500 and DJCS Long/Short Equity Index, respectively.

The strategy successfully captured 73 percent of upside of the S&P 500 in a rising market, while avoiding losses, capturing only 37 percent of the S&P downside in a falling market. The approach also displays low overall correlations (R²) with either of the indexes, and the back tested monthly returns data were found to be positively skewed. The ETF has a 0.95 percent expense ratio.

Again, until there is a real time price history, I would not take any positions in an only back tested ETF no matter how promising the theoretical returns appear.

Disclosure: No holdings

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