Active Factor Investing: Hedge Funds vs. the Rest of Us

23 Pages Posted: 2 Dec 2014 Last revised: 19 Aug 2017

Jun Duanmu

Louisiana Tech University - Department of Economics and Finance

Yongjia Li

Boise State University - College of Business and Economics, Department of Finance

Alexey Malakhov

University of Arkansas, Fayetteville - Sam M. Walton College of Business, Department of Finance

Date Written: August 2017

Abstract

We argue that only hedge funds whose returns are driven by beta management of exposures to latent risk factors could be successfully replicated. We develop a methodology for creating a portfolio of ETFs that replicates risk factor exposures taken by successful beta active cloneable hedge funds. The methodology allows any investor to access active factor strategies employed by hedge funds. It could be interpreted as cloning beta exposures of the best beta active hedge funds, delivering outstanding long-term risk-adjusted performance. The active factor ETF portfolio only requires annual rebalancing, and is constructed with a transparent algorithmic approach, which conforms to a definition of a smart beta strategy.

Keywords: hedge funds, risk factor exposures, factor investing, return replication, performance prediction, beta active management, smart beta

JEL Classification: G11, G23

Suggested Citation

Duanmu, Jun and Li, Yongjia and Malakhov, Alexey, Active Factor Investing: Hedge Funds vs. the Rest of Us (August 2017). Available at SSRN: https://ssrn.com/abstract=2532806 or http://dx.doi.org/10.2139/ssrn.2532806

Jun Duanmu

Louisiana Tech University - Department of Economics and Finance ( email )

Ruston, LA 71272
United States

Yongjia Li

Boise State University - College of Business and Economics, Department of Finance ( email )

1910 University Drive
Boise, ID 83716
United States

Alexey Malakhov (Contact Author)

University of Arkansas, Fayetteville - Sam M. Walton College of Business, Department of Finance ( email )

Fayetteville, AR 72701
United States
479-575-6118 (Phone)
479-575-4230 (Fax)

HOME PAGE: http://www.alexeymalakhov.com

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