Even though the definition of "hedge fund" has changed over time, morphing from largely market-neutral strategies to a much wider variety of leveraged strategies, most retail investors still can't get into these lucrative funds. As such, the IQ Hedge Multi-Strategy Tracker ETF (QAI) is an intriguing offering, as it seeks to replicate the performance of a group of diverse hedge fund investing styles including: long/short equity, event-driven, and fixed income arbitrage.

In A Nutshell

QAI doesn't fit neatly into a nutshell. The fund tracks the IQ Hedge Multi-Strategy Index, a unique benchmark that is rebalanced monthly and is designed to reflect a host of popular hedge fund strategies including long/short equity, fixed income arb, event-driven trading, and even some currency strategies. This fund was launched in March of 2009 and holds over $270 million in assets .

What Makes QAI Unique

There are very few other ETFs that explicitly attempt to replicate a mix of hedge fund strategies, which makes QAI quite the unique instrument. Suffice it to say, the IQ Hedge Multi-Strategy Index is not a well-known benchmark.

QAI is also unusual, in that it is actually an exchange-traded fund of funds; as such, the fund's holdings are other ETFs, ETNs, and exchange-traded trusts.

How It Fits

QAI offers investors an opportunity to take advantage of the "heads I win & tails I win" philosophy that originally drove the growth of market-neutral hedge fund strategies. The monthly rebalancing of this fund would appear to make it a relatively poor candidate for trading and investors may find that the diverse holdings in fixed income, currencies and so forth offer convenient one-stop diversification. That said, it is difficult to say that this fund is well-suited as a core holding for risk-averse investors .

What It'll Cost You

Due in part to the fact that this fund holds other funds that charge expenses, the effective expense ratio for this fund is high at 1.03% (despite a stated expense ratio of 0.75%). In the very limited universe of hedge fund ETFs, QAI's fees are towards the more expensive end of the cost spectrum which spans from 0.45% and 1.64%, with an average of 0.78%. QAI is not available forcommissionfree trading .

Under The Hood

QAI's allocation changes monthly, although well-known fixed income funds like iShares Barclays 1 -3 Year Treasury Bond (SHY) and iShares iBOXX Investment Grade Corporate Bond (LQD) can typical be found in the fund's top holdings. Currency holdings account for more than one-tenth of total assets while stocks make up about double that amount .

Investors must also note that this fund will invest in inverse ETFs. Although this is arguably done to replicate the short positions that hedge funds take, it is not the same thing; holding inverse ETFs beyond a day or two creates volatility drag and can produce significant tracking error. Consequently, QAI struggles to truly replicate some of the more complex strategies used by hedge funds.

Yield, Volatility and Performance

QAI features an annual dividenddistribution. In terms of performance, context is important. QAI is not structured as an absolute return fund, and thus its performance in 2010 and 2011 lagged the S&P 500, gaining 2.58% and 0.15% respectively. The fund's returns have also been inferior to others in the alternatives space, but the small size of that group limits the utility of that comparison. As the returns of the U.S. stock market have been positive since the fund's launch, it has not had the opportunity to show what should be its biggest selling point - superior (or at least consistent) returns during bear markets .

Other Options

The hedge fund replication approach has not really caught on, but there are a few other funds taking generally similar approaches. Investors could also consider:

  • Credit Suisse Merger Arbitrage Liquid Index (CSMA): This instrument looks to replicate a merger arbitrage strategy by using a quantitative-based methodology to track a dynamic basket of securities.
  • Managed Futures Strategy Fund (WDTI): This actively-managed ETFemploys a unique long/short managed futures strategy that incorporates a diversified basket of exchange-traded commodity and financial futures contracts.
  • ProShares Hedge Replication (HDG):This fund tracks an index based on the Merrill Lynch Factor Model toaccomplish its hedge fund-like objective; HDG establishes weighted long or short exposure to six distinct factors, including U.S. equities, international stocks, Treasuries, and the euro.
Disclosure: No positions at time of writing.

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