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The Journal of Alternative Investments

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Article

What Drives the Tracking Error of Hedge Fund Clones?

Arik Ben Dor, Ravi Jagannathan, Iwan Meier and Zhe Xu
The Journal of Alternative Investments Fall 2012, 15 (2) 54-74; DOI: https://doi.org/10.3905/jai.2012.15.2.054
Arik Ben Dor
is a managing director in the Quantitative Portfolio Strategy Group at Barclays in New York, NY.
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  • For correspondence: arik.bendor@barclays.com
Ravi Jagannathan
is the Chicago Mercantile Exchange/John F. Sandner Distinguished Professor of Finance at the Kellogg School of Management in Evanston, IL, and a Special-Term Professor at the Shanghai Advanced Institute of Finance.
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  • For correspondence: rjaganna@kellogg.northwestern.edu
Iwan Meier
is an associate professor of finance at HEC Montréal in Montréal, Québec, Canada.
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  • For correspondence: iwan.meier@hec.ca
Zhe Xu
is a vice president in the Quantitative Portfolio Strategy Group at Barclays in New York, NY.
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  • For correspondence: jason.xu@barclays.com
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Abstract

Hedge fund clones provide a liquid, efficient, and transparent alternative to investing in hedge funds. As a group, however, their recent performance has been disappointing, despite the large variation in the replication methodologies used. The author investigates hedge fund clones’ tracking errors and finds that contrary to common belief, the reliance on historical data to “reverse engineer” hedge fund allocation is not the primary cause. Instead, the author identifies two important drivers of tracking errors of hedge fund clones. One is changes in marketwide liquidity levels as measured by the basis between derivatives and cash securities. The second is biases in measuring the returns that arise due to attrition among hedge funds that affect the performance of commonly used hedge fund indices. Together, they account for about half of the variation in hedge fund clones’ tracking errors over time.

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The Journal of Alternative Investments: 15 (2)
The Journal of Alternative Investments
Vol. 15, Issue 2
Fall 2012
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What Drives the Tracking Error of Hedge Fund Clones?
Arik Ben Dor, Ravi Jagannathan, Iwan Meier, Zhe Xu
The Journal of Alternative Investments Sep 2012, 15 (2) 54-74; DOI: 10.3905/jai.2012.15.2.054

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What Drives the Tracking Error of Hedge Fund Clones?
Arik Ben Dor, Ravi Jagannathan, Iwan Meier, Zhe Xu
The Journal of Alternative Investments Sep 2012, 15 (2) 54-74; DOI: 10.3905/jai.2012.15.2.054
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  • Article
    • Abstract
    • THE PERFORMANCE OF HEDGE FUND CLONES DURING THE FINANCIAL CRISIS
    • IS THE FINANCIAL CRISIS DIFFERENT FROM PREVIOUS FINANCIAL TURMOIL?
    • WHAT EXPLAINS THE UNDERPERFORMANCE OF HEDGE FUND CLONES AFTER THE FINANCIAL CRISIS?
    • POTENTIAL USE OF CLONES AS A BENCHMARK FOR FUND OF HEDGE FUNDS
    • SUMMARY
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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