While plain-vanilla equity ETFs have always been an investor favorite, there are several compelling options that tap into unique hedge fund-like strategies, such as the AlphaClone Alternative Alpha ETF (ALFA ).
Inside ALFA's Strategy
Making its debut in 2012, Exchange Traded Concepts’ ALFA takes a unique approach to the Hedge Fund ETF space. The fund tracks the AlphaClone Hedge Fund Long/Short Index, which is designed to measure the performance of US-traded equity securities to which hedge funds and institutional investors have disclosed significant exposure.
The index ranks hedge funds and institutional investors based on the efficacy of replicating their publicity disclosed positions. Equities are then selected from those managers with the highest ranking, or “Clone Score”. More specifically, the Clone Score looks at the the monthly returns in excess of a broad market index and a fixed hurdle rate exhibited by the manager’s follow strategies over time.
After funds with the highest Clone Score are selected, the constituents are equally weighted but have an “overlap bias”, meaning those securities held by twice the number of managers have twice the weight.
It is also important to note that the index is risk managed in that it can vary between being long only and market hedged based on certain rules-driven relative price targets tied to a broad market index. These price targets are when the S&P 500 crosses its 200 day moving average at any month end.
ALFA's Portfolio
ALFA’s portfolio consist of approximately 80 individual holdings, though this number does change quite frequently. In general, ALFA invests the vast majority of its assets in U.S. equities, though a fraction is sometimes allocated to foreign stocks. In terms of market capitalization, ALFA is quite diversified across sizes, including giant, large, and mid-cap firms, while at the same time holding some exposure to small and micro-cap stocks. The fund’s sector breakdown also features diversified exposure, though technology and healthcare stocks do receive hefty allocations (as of 4/13/2015).
Considerations on ALFA's Performance
Given ALFA’s hedge-fund replication approach, the fund is more suited for investors with more aggressive risk/return profiles than traditional low-risk buy-and-hold portfolios. As mentioned, ALFA’s hefty allocation towards technology and consumer cyclicals could pose a potential bias, as these sectors tend to exhibit higher levels of volatility than “safer” sectors such as consumer staples or utilities. In addition, the fund does have roughly 20% invested in small and micro-cap firms, which are inherently riskier than their large-cap counterparts.
It is important to note, that ALFA’s underlying index is rebalanced quarterly and should be closely monitored.
How to Use ALFA in a Portfolio
For those looking for a relatively cheap and efficient way to tap into hedge fund strategies, the AlphaClone Alternative Alpha ETF (ALFA ) is a compelling option. The Clone Score, in particular, helps hone in on only those funds and managers with solid track records. In addition, the fund’s ability to essentially hedge its position (based on the S&P 500’s 200-day moving average), allows it to potentially mitigate downside risk. For more aggressive investors, ALFA could be used as a core holding, though a supplementary allocation to this fund may be more appropriate.
ALFA charges an expense ratio of 0.95%, which is slightly above the average Hedge Fund ETF fee.
The Bottom Line
The AlphaClone Alternative Alpha ETF (ALFA ) is a compelling option for those looking gain direct access to stock positions favored by established hedge funds. In addition, its unique methodology offers investors great potential for capital appreciation. As always, be sure to do your own research to determine whether or not this ETF fits into your overall strategy before making an allocation.
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Disclosure: No positions at time of writing.
