Hedge Fund Replication: A Model Combination Approach
Review of Finance, Forthcoming
48 Pages Posted: 25 Jan 2015 Last revised: 21 Jun 2016
Date Written: June 17, 2016
Recent years have seen increased demand from institutional investors for passive replication products that track the performance of hedge fund strategies using liquid investable assets such as futures contracts. In practice, linear replication methods suffer from poor tracking performance and high turnover. We propose a model combination approach to index replication that pools information from a diverse set of pre-specified factor models. Compared to existing methods, the pooled clone strategies yield consistently lower tracking errors, generate less severe portfolio drawdowns, and require substantially smaller trading volume. The pooled hedge fund clones also provide economic benefits in a portfolio allocation context.
Keywords: Hedge funds, Model pooling, Model combination, Hedge fund replication, Log score
JEL Classification: C11, C51, C53, C58, G17
Suggested Citation: Suggested Citation