Hedge fund assets have ballooned in the past decade, and in response Zurich Capital Markets has launched indices to track the sector and its own investable product based on those benchmarks.
The Zurich Hedge Fund Indices are a series of benchmarks that will track the performance of five different hedge fund investment strategies – convertible arbitrage, merger arbitrage, distressed securities, event driven and hedged equity.
As an extension of the new benchmarks, Zurich has also set up the Zurich Insititutional Benchmark Series – investable products that are designed to give the returns of the hedge fund indices.
“The Institutional Benchmark Series is designed to give investors exposure to a range of hedge fund styles, without the need to select individual managers,” the company says in a statement. “By delivering style consistency across the selected managers, the series offers overall returns similar to each style, over any given period,” it says.
The methods of manager selection and tracking optimisation that ZCM has used will give higher directional correlation and lower tracking error than any other indices, the firm claims.
ZCM says the series will also accommodate those institutional investors that cannot normally invest in hedge funds for structural reasons. The investment policies of many institutions restrict leverage and the use of derivatives, and have concerns about liquidity, transparency and operational risk, it says.
Because of the way they are run, the benchmarks give broader access to hedge fund styles. Not only does ZCM perform rigorous due diligence analysis on each candidate fund, but it also has clear investment guidelines that reflect industry ‘best practices’, monitors the separate account portfolios every day and provides a realistic platform for risk analysis and portfolio optimisation, it says.
Zurich says the new indices are the result of its own research in association with hedge fund specialist Schneeweis Partners. It has sought to identify ‘strategy pure’ hedge funds within each hedge fund strategy, it says.
Assets under management in the hedge fund industry have grown from less than $25bn (e28.4bn) in 1990 to over $500bn last year, according to ZCM. The firm attributes this huge increase in part to the emergence of new financial vehicles and also to changes in technology that have made sophisticated investment strategies possible without the infrastructure of a large investment firm.
Although there are already several benchmarks in existence that track hedge fund performance, ZCM saw a gap in the market. “The first issue for us was to establish a standard for the industry,” says ZCM senior executive officer Nick Corcoran. “We looked at a lot of products in the market... They were just databases which collected data but didn’t have a methodology for verifying returns,” he says.
ZCM aimed for an index which is transparent and academically robust, and one which returns which are style-pure. “We’re trying to bring the whole industry to the institutions, and by eliminating the institutions’ concerns, we’ve basically done that,” says Corcoran.
Looking at the range of returns produced by a large group of hedge funds which claim their style is convertible arbitrage, for example, Corcoran says it is clear that because some of the returns are so far out of the cluster they must be using some other strategy.
Although there is a global universe of several thousand hedge funds, for each of the indices, ZCM has chosen a limited number of hedge funds to track – between eight and 17, depending on the index. Zurich’s main criteria for inclusion in the index are strategy purity, two-year minimum performance track record and sufficient assets.
However, for the indices, there is no requirement that the funds included be open to new investments. This is because the indices are only constructed to reflect the returns of a particular hedge fund strategy and are not designed to be directly investable.
But the Institutional Benchmark Series is not only investable but also flexible, says Corcoran. It can be tailored to individual clients’ needs, for example the risk profile could be lowered for a particular institution, he says.
Because of the indices’ methodology, the benchmark series product based on them is style-pure, liquid and transparent, says ZCM. The risk of selecting the wrong manager has been eliminated. “It becomes a more acceptable asset class for portfolio diversification strategy,” says Corcoran.
Zurich says that as with traditional stock and bond indices, these hedge fund indices are designed to evolve. An index committee which is made up of leading pension fund and mutual fund investment officers will rview all aspects of methodology and construction. As well as reviewing the way the indices are structured, the committee may propose new criteria for fund selection, says ZCM.
l During the market sell-off in February, the CSFB/Tremont Hedge Fund Index fell 0.6%, its providers said. This showed that hedge funds managed to limit losses for broadly diversified investors in that month, said the provider.

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