The Value-Added of Investable Hedge Fund Indices

This paper empirically investigates the risk and performance of three types of alternative betaproducts over the January 2002 to September 2009 time period: funds of hedge funds (FHFs),investable hedge fund indices (IHFIs), and hedge fund replication strategies (HFRS). Weshow that IHFIs are true alternative beta products with high correlations and beta to noninvestablehedge fund indices. Our results further suggest that, in a best case scenario, IHFIsoutperform FHFs and HFRS on a risk-adjusted basis. However, in the worst case scenario,IHFIs underperform both investments. If we take the average of all IHFIs, we find theyperform equally well as FHFs. Hence, IHFIs constitute a solid alternative to FHF investments,while costing substantially less, and offering generally more transparency and liquidity. Wepropose that fee-sensitive investors especially should consider taking a core-satellite approachto their hedge fund portfolio, with the core represented by cheap passive hedge fund betathrough IHFIs, and the satellite represented by more expensive and actively managed alphageneratingFHFs.