Factor-Based Hedge Fund Replication Using Exchange-Traded Funds

Sammanfattning: This paper studies the performance of factor-based hedge fund replication. We use monthly data of nine exchange-traded funds to estimate clone portfolios over the sample period 2008-2016 for eleven different hedge fund indices. We find that clones are capable of capturing a large part of the return characteristics of certain hedge fund strategies, although the clones generally underperform the indices. We further find that the use of factor selection and shrinkage methodologies improves replication results and leads to lower underperformance and portfolio turnover. The stepwise regression model shows the best out-of-sample performance, although a backtest shows that clones underperform the hedge fund indices more severely over a longer time span.