The process for implementing the portfolio is to track, as closely as possible before fees and expenses, the IQ Hedge Multi-Strategy Index, which is based on the premise that the risk-return characteristics of hedge funds are valuable additions to a diversified portfolio. A substantial body of academic research has developed that documents the large “beta” (or asset class exposure) component relative to the “alpha” (or true manage skill) component of hedge fund returns. The investment process of the portfolio was designed to use ETFs, exchange-traded notes (ETNs), and other exchange-traded vehicles (ETVs) to capture the systematic or “beta” component of hedge fund returns. It is a rules-based methodology that does not allow for subjective or active asset allocation decisions.
The process consists of the following steps:
1. Applying minimum asset constraints and other filters to the universe of all ETFs to eliminate illiquid ETFs. The filtering process is conducted annually.
2. Mapping relevant ETFs to specific hedge fund styles based on quantitative calculations as well as a qualitative assessment of the relevance of the selected ETFs to the hedge fund style (mapping is reviewed and adjusted as necessary on an annual basis).
3. Estimating, via regression, the optimal exposures for each ETF within each hedge fund style (regression is performed monthly).
4. Estimating the optimal combination of the hedge fund styles to allow the fund to seek to achieve its objective (optimization is performed monthly).
5. Combining the exposures to each ETF within each hedge fund style with the optimal allocation across hedge fund styles (the combining is performed monthly).
6. For our mutual fund, we apply 25% leverage to all positions in the portfolio.
Our robust process has resulted in IndexIQ investment solutions serving as building blocks for modern portfolio diversification, characterized by:
- Low Volatility
- Attractive Up/Down Capture
- Low Correlation to Traditional Asset Classes
- Liquid, Transparent, Low Cost, Tax Efficient
Moreover, by using liquid ETFs in a process that has full transparency and full disclosure of the positions, the portfolio seeks to provide investors, in a cost effective manner, the positive attributes of hedge funds, while eliminating the structural issues that limit their accessibility and appeal.