MiB: How to Replicate Hedge Funds in an ETF



When you start your hedge fund career at Seth Klarman’s Baupost Group, it is easy to see how everything else after that is a disappointment. That was only part of the issues confronting Andrew Beer, founder and managing member of Dynamic Beta investments (DBi).

Beer sought to address industry issues including illiquidity, high costs, lack of transparency, and “single manager risk.” DBi’s answer was to create several ETFs that seek to replicate illiquid alternatives at lower costs, with full transparency and comparable after fee performance. He notes that hedge funds are unconstrained, providing flexibility beyond the mutual fund style box. Finding a way to duplicate their positives while removing the negatives has been the holy grail for the “Liquid alts” sector.

The firm aims to reverse engineer the best of the industry’s allocations. Assuming the biggest consistent long-term generator of alpha is sector allocation, DBi tracks 40 of the largest best performing funds’ monthly performance to drive their own allocation decisions. Replicating this allocation in an ETF wrapper provides daily liquidity and transparency while still capturing after fee performance. DBi’s hedge fund replication fund, iM DBi Long Short Hedge Strategy ETF (DBEH) is up over 30% since it launched in December 2019, versus the S&P500 index, up 20% over the same time period.

His explanation as to why hedge fund fees remain so high: The people who allocate to hedge funds are allocating other people’s money (OPM) so “they really don’t care about fees.”

A list of his favorite books are here; A transcript of our conversation is available here.

You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, StitcherGoogle, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here

Be sure to check out our Masters in Business next week with the legendary fund manager Ron Baron of Baron Funds. Founded in 1982, the firm is known for long-term, fundamental, active approach to growth investing, and has $49 billion in AUM. 16 of 17 Baron Funds, representing 98.3% of assets outperformed their passive benchmark since inception; the Baron Partners Fund was up +148% in 2020.



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