ValueWalk – Recent years have seen increased demand from institutional investors for passive replication products that track the performance of hedge fund strategies. These “clones” offer the diversification benefits of hedge-fund-like investments, while simultaneously providing superior fee structures, scalability, transparency, and liquidity. We find that, in practice, linear replication methods routinely suffer from poor tracking performance and high turnover. To address these concerns, we propose a model combination approach to index replication that effectively pools information from a diverse set of pre-specified factor models. Compared to existing approaches, the pooled clone strategies yield consistently lower tracking errors, generate less severe portfolio drawdowns, and require substantially smaller trading volume. The pooled hedge fund clones also provide economic benefits in a portfolio allocation context.

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