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Hedge Fund Replication and Alternative Beta – an overview

Interest in hedge fund replication appears to be re-awakening. Perhaps stirred by the popularity of smart beta and factor models in general, alternative beta strategies are receiving more attention, and recent months have seen the launch of a number of new hedge fund replication ETFs. 

Therefore, it seems an opportune time to review the best papers and research on hedge fund replication and alternative beta.

The premise behind hedge fund replication is that almost all of the return from hedge fund indices can be described in terms of market betas and alternative betas.


“Alternative beta” refers to risk exposures, commonly exhibited by hedge funds, which can be mechanically replicated (either long, short, or dynamically) and therefore can become investable propositions, either as stand-alone products, or as portfolio risk factors.

In this way, alternative beta products can replicate the systematic exposures from a range of hedge fund strategies, including long-short equity, convertible bond arbitrage, merger arb, and even global macro.

These alternative beta risk factors could include “smart beta” type equity factors (e.g. value, size, quality) or currency factors (carry, momentum) or option-based or other rule-based, algorithmic factors which are commonly employed (in aggregate) by hedge funds in one sector or another.

In fact, a recent paper by two academics from Monash University in Melbourne, Australia, argues that most hedge funds should be considered to be passive, not active – their research suggesting that the returns of more than 60% of hedge funds can be entirely explained by linear exposure to basic risk factors.

This is not a novel view, however. The first flurry of activity in this field was back in 2005-2007, when academics such as Harry Kat, Bill Fung, David Hsieh, Andrew Lo and practitioners such as Lars Jaeger were breaking new ground and developing the concepts behind the initial roll-out of products. I remember it well, as I produced the world’s first Hedge Fund Replication conference during that time.

After some initial interest in the products, enthusiasm dampened down, but the basic inspiration behind the products – to produce hedge fund-like returns without paying hedge fund-like fees – remains as valid now as it was then. Recent months have seen a number of launches of hedge fund replicating ETFs – so perhaps interest in the concept is on the rise again.


See the full list of our hedge fund white papers, look more broadly at our papers on factor investing or go straight to one of our recommended papers, below, on hedge fund replication and alternative beta:

Passive Hedge Funds Tupitsyn and Lajbcygier (2015)

The authors put forward evidence to argue that most hedge funds are essentially managed passively rather than actively. This is argued on the basis that most hedge funds have only linear exposures to the factors which drive HF returns.

Hedge Fund Replication Hewitt EnnisKnupp (2013)

This study analyses the success of hedge fund replication products against their stated objectives. Do they do what they claim, and are they a useful tool for asset owners and portfolio managers?

Alternative Beta bfinance (2015)

A 10 page study of “alternative beta” or “hedge fund beta”, which bfinance defines as the capture of risk premiums (outside of traditional equity and fixed income market beta) using passive or rule-based strategies.

Using alternative betas for diversification Columbia Threadneedle (2015)

Columbia Threadneedle explore the ways in which alternative beta risk exposures can be used to contribute additional, uncorrelated risk diversification to either traditional funds or alternative portfolios.

Hedge funds in strategic asset allocation Lyxor Asset Management (2014)

This wide ranging analysis from Lyxor examines a variety of hedge fund strategies and describes their underlying risk exposures. By understanding these market betas and alternative betas, investors can work out the optimal way of integrating hedge fund strategies into an asset allocation framework.

A Copula-Based Approach to Hedge Fund Return Replication Harry Kat (2005)

From the ebullient Professor Harry Kat, one of the original papers in this field. This paper presents a “copula-based” process to emulate trading strategies, in order to derive hedge fund-like returns. The paper argues that these, “synthetic” HF returns are superior to normal hedge fund returns, due to their relative simplicity and removal of many of the risks involved with real hedge funds.

Keep It Simple - Avoid Uncompensated Complexity in Portfolios SSGA (2014)

While SSGA have faith in active management, they argue that some portfolio strategies are un-necessarily complex, and can be replicated, relatively simply, at a lower cost.

Can Hedge-Fund Returns Be Replicated?: The Linear Case Hasanhodzic and Lo (2006)

This early paper derives linear factor models for over 1600 individual hedge funds, and measures the extent to which the returns of these funds can be explained using linear factors, based on data from 1986 to 2005. The results show that for certain hedge fund strategies, the results – though inferior to the real thing – are comparable.


Andrew Perrins is a former Actuary and Asset Allocator. After qualifying as an Actuary, he worked for 15 years in investment management, serving as Director of Asset Allocation for Abbey Life and for Chase Manhattan, before setting out on a more entrepreneurial path.

See Andrew’s Linkedin bio at  

To contact Andrew, email

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