Goldman Replicator: Mixed but Promising Results

Chidem Kurdas

Goldman Sachs runs a hedge fund tracking strategy that buys and sells instruments like futures contracts according to a benchmark. Replicating hedge fund returns has been a topic of interest to investors for several years.

So how does the Goldman tracker compare to actual hedge funds? There’s some bad news. In 2009, Class A shares in the Goldman tracker fund returned 5.75%. That’s substantially lower than returns for hedge funds as a group.

Index investments, of course, usually return less than their benchmark because of various expenses, including trading commissions. In 2009 the gap between the Goldman hedge fund replicator and its benchmark  – 5.75% vs. 7.8% – was wider than the fund’s net expense ratio. But the gross expense ratio is pretty high, presumably reflecting the cost of the derivative instruments traded.

More importantly, both the fund and its benchmark trail the Credit Suisse/Tremont All-Hedge Index, which made 16.3%, reflecting the performance of a large number of hedge funds across different strategies. This big difference could be due to manager skill playing a major role in 2009.  The idea behind replicating is to catch the gains that result from market exposure rather than manager skill, which a tracker cannot reproduce.

The market exposure returns are called alternative beta. In 2009, a large contingent of hedge funds went up with the stock market, which suggests that alternative beta was large.

Goldman’s tracker most likely missed a portion of the potential gain because its allocation to equities was relatively light. Toward the end of the year, the equity part was boosted with the addition of a long exposure to the S&P 500. Another factor is that the tracker was short credit, which helped early in the year but then became a drag as credit recovered.

On the other hand, if you consider the past two years, the tracker did better than hedge funds. It did not lose as much in 2008, probably because it largely went to cash as the Lehman Brothers crisis unfolded. All in all, an investor would have been better off parking money in the replicator during 2008-2009 rather than in most fund of hedge funds.

Putting aside relative performance, the tracker has great advantages. It is a liquid investment with no danger of frozen redemptions. And while the Goldman quants who manage the benchmark may make mistakes, there is no manager risk comparable to, say, getting in with the next Bernard Madoff.

Goldman’s fund is one of a growing number of trackers that use a variety of methods. Just today a report showed up that Finles Capital is launching the first index tracker focused on Dutch-based hedge funds, to attract institutions.

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