RT Journal Article SR Electronic T1 What Drives the Tracking Error of Hedge Fund Clones? JF The Journal of Alternative Investments FD Institutional Investor Journals SP 54 OP 74 DO 10.3905/jai.2012.15.2.054 VO 15 IS 2 A1 Dor, Arik Ben A1 Jagannathan, Ravi A1 Meier, Iwan A1 Xu, Zhe YR 2012 UL http://jai.pm-research.com/content/15/2/54.abstract AB 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.