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27 Feb 2008

Study On Synthetic Hedge Fund Indices

Synthetic hedge fund indices (SHFIs), also known as 'hedge fund clones' were introduced in 2007, following years of academic research. SHFIs are dynamically managed portfolios of liquid assets (also called replicating factors, which usually exist in futures and exchange-traded funds) that aim at minimising the tracking error with a target non-investable hedge fund index.

Based on research by Innocap Investment Management's, there are four criteria which should be met by SHFIs; they should be representative of the investment universe, transparent, have consistent weighting, timely reporting, stable performance over time, and they should be investable.

SHFIs are to hedge funds what exhange traded funds (ETFs) are to mutual funds, a liquid, low-cost and transparent way to expose a portfolio to the asset class. SHFIs that target a good hedge fund index and use a sophisticated tracking model applied to a wide range of liquid and transparent financial instruments should exhibit an interesting risk-return profile, particularly for the liquidity risk conscious investors.

SHFIs currently constitute a small portion of all hedge fund assets under management because they have been introduced quite recently. Nevertheless, they now constitute a key element in the alternative assets offering of the biggest financial institutions.

Innocap Investment Management is a subsidiary of the National Bank of Canada [TSX: NA-T], it was created to supervise all of the bank's alternative investments activities in capital markets.

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