AlphaClone launched the AlphaClone Alternative Alpha Exchange-Traded Fund (ALFA) earlier this year which will invest in the positions of selected hedge funds that demonstrate the highest “clone score”…which is AlphaClone’s proprietary metric that measures the efficacy of following a manager based on their publicly disclosed holdings.  The ETF also includes a “dynamic hedging mechanism” using the SPY  (it’s  a moving-average crossover strategy) thus giving a “hedged” quality.

Let’s take a closer look at the prospectus for some details on what investors are actually getting…

“The AlphaClone Hedge Fund Long/Short Index represents equity securities that are favored by hedge funds and institutional investors in their public disclosures. The index is equal weighted with an overlap bias which gives a security held by twice the number of managers twice the weight. The index is reconstituted quarterly and can vary between being long only and market neutral.”

A few things stand out:

1. The universe of filers is only 300 large (click here for the full list).

A quick look at this list reveals that most of these filers are not appropriate for this type of replication – so the effective universe is actually much smaller.  Consider filers such as AXA, for example, or Fidelity (FMR) or Legg Mason that comprise multiple business units with 1000′s of different equity holdings of hundreds of different mutual funds….a 13F filing conveys NO useful information for these types of filers and is clearly not appropriate for a “cloning” type strategy regardless of what the “clone score” shows.

1. The actual selection of which equity holdings go into the index appears to be somewhat discretionary.  “On the Selection Day, AlphaClone selects up to 100 constituents derived from the eligible list of securities”.  

This is not as “passive” as many investors probably expected.  Rather than set a rule (top 1 position, top 5 positions, etc.) it appears that AlphaClone is simply selecting stocks from an “eligible” universe of the holdings of these 300 filers (hopefully not all).

1. The “Clone Score” is not technically a measure of how close a replicated portfolio of disclosed holdings is to the actual hedge fund returns but just a measure of how well that portfolio of disclosed holdings beats the S&P (plus some hurdle rate).

 Since getting the actual returns of hedge funds is difficult – measuring the suitability of a filer to a holdings-based replication approach using excess returns is as good a measure as any (we believe).  

What’s interesting, however, is that our own research (on our database of ALL 3,000+ filers) reveals MANY non-hedge fund filers that demonstrate excellent backtests when piggybacking off their top holdings.  This would include smaller wealth management firms, institutions and publicly traded companies.  While the top holdings of hedge funds make for great marketing, the truth is that copying the top picks of most funds is simply NOT a good strategy over time.  There are some for which this is a great strategy but one must be very careful in this selection….and there are simply too many excellent non-hedge fund filers out there that can’t be ignored.

Deconstructing the ALFA ETF

As a next step, we ran the actual holdings and weights of the ALFA ETF through our software and cross-checked that with all of the holdings of all 300 filers in their universe in order to triangulate in on which ones are more important in contributing to the “eligible list of securities” from which the AlphaClone committee ultimately constructs the ETF.

Of AlphaClone’s universe of filers, only 231 had at least 1 position in any of the 83 stocks held in the ETF.

The average number of stocks held by those 231 filers was 16.4 with one filer holding 79 of the 83 (although it was INVESCO LTD….not a hedge fund and not a good filer to have in the universe at all).

We ran each of these 231 filers through our software and ranked each holding in Q1 2012 as a % of each filer’s total reported holdings.  So, the biggest position is “1″, second largest is “2″ and so on.  This allows us to look at each filer and see :

(i)  if they held one of the equities in the ALFA ETF

(ii)…and if so, how important was it in their portfolio (i.e. was it the top position or the bottom one?)

 

A breakdown by each filer is shownhere

A comprehensive analysis of the filer’s ALFA holdings can be downloaded here.

…as can be seen, several of the filers in AlphaClone’s “universe” had a position in one (or many) of the stocks in the ALFA etf, but in most cases they were very low ranked positions within the filer’s portoflio.

This is why we looked at which filers had several of their top ranked (i.e. high conviction) picks among the stocks in the ALFA etf.

By focusing on just those filers that had at least 5 of the ALFA holdings among their top 10 we get a list of 61 filers (excluding the obviously inappropriate ones such as Bank of NY Mellon,Blackrock, etc) whose holdings very likely contributed to the “eligible securities universe” from which the AlphaClone committee selected the ALFA holdings.

This list includes many of the “ususal suspects” of the hedge fund world:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We will continue to examine this ETF in an effort to help the investing community fully understand the exposures they’re getting but suffice it to say for now…caveat emptor.