Hedge funds are the preserve of wealthy individuals and institutional investors, but U.K. hedge fund manager Marshall Wace, which manages over $5 billion in assets, is effectively dropping its membership requirements with the planned launch of an exchange-traded fund (ETF) that will replicate one of its flagship strategies. Should you own this ETF?
Don't be so passive!
Most ETFs, including the SPDR S&P 500 (NYSE: SPY ) , the iShares MSCI Emerging Markets Index (NYSE: EEM ) , or the iShares MSCI EAFE Index (NYSE: EFA ) are "passive" vehicles -- they simply track an index. The Marshall Wace Tops Global Alpha ETF will mirror the stock positions of six existing Marshall Wace Tops funds, which are actively managed.
The Tops strategy relies on a systematic tracking and ranking of hundreds of analyst stock recommendations from brokers (Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , etc.), according to a proprietary algorithm, in order to select the best ideas. Just how active is "active"? Marshall Wace turns over its European portfolios 12 to 18 times a year, for an average holding period of about 24 days. Despite the enormous costs associated with such frenzied trading -- approximately 5.4% a year for the European funds -- the six Tops funds have produced an average annual return of 10.9%, well ahead of stock benchmarks.
Risks and opportunity
My concerns with this ETF are two-fold. First, the triple layer of fees creates a high hurdle for outperformance (0.25% in ETF administration fees, on top of the already generous 1.5% of assets and 20% performance fee that is typical for hedge funds -- Marshall Wace are "hyper-Helpers," to use Berkshire Hathaway (NYSE: BRK-A ) CEO Warren Buffett's ironic expression). Second, I wonder if the mechanics of creating/managing stock baskets for an ETF won't make it easier for competitors to mimic the strategy, eroding its returns.
ETFs can be tremendous tools for asset allocation, but the best ones are low-cost, plain index ETFs. As a rule, investors should avoid overly complex products (leveraged long or short ETFs, for example); nonetheless, I'm going to reserve judgment on this new entrant for now. If Marshall Wace can replicate (and maintain) the performance of Tops, this ETF will enable individual investors to get high-quality exposure to hedge fund strategies.
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