AlphaClone: Assemble Your Fantasy Hedge Fund Team ... And Win

American flag is hung on the exterior of the New York Stock Exchange
American flag is hung on the exterior of the New York Stock Exchange

It's difficult for an ordinary person to gain access to the world of high-performing hedge funds.

Your average retail investor has neither the minimum level of wealth to invest that those hedge fund managers require, nor can she afford to pay their exorbitant fees. In a way, getting into that part of the investing world is like playing in the NFL: A tiny elite can do it and make millions while the rest of us can only watch and dream.

Well, just as we mere mortals can coach our way to gridiron victory through fantasy football teams, now hedge funds have a "fantasy team" option too, and it's one that can help you score some nice returns.

Send in the Clones

Maz Jadallah, founder of AlphaClone, created his company in 2008 to help make that fantasy a reality. His firm is a pioneer in the art of tracking the publicly disclosed holdings of top hedge funds, and showing retail investors how to use those public filings to their advantage. Moreover, it gives you a peek into the strategies of top money managers. In essence, AlphaClone helps you assemble your personal dream team of investing pros.

Jadallah, a self-described "data geek and avid investor," had long searched for a way to bolster his own lackluster investing skills.

Like many of us, he grew frustrated with mutual funds and unresponsive wealth management advisors. Wealth management firms offered him boilerplate portfolios and no downside protection; money managers typically met with clients once a year, neglected their profiles, and left them to wallow in mediocre returns.

Jadallah wanted to have higher-quality options to choose from, and on Wall Street, those are the hedge fund managers: Like star quarterbacks or wide receivers, they're the investing world's MVPs.

But how to get them on his team? "I stumbled upon the fact that these guys have to disclose their positions each quarter," Jadallah said. So there was his "draft": Fund managers' 13F filings -- each one filled with valuable, but not fully secret, data. In essence, he was parsing out the methods to their investing madness. He was inside the huddle, as it were.

Jadallah built a research platform that extended back to 2000 to clone or back-test different strategies from each hedge fund manager.

"What happens in one of Warren Buffet's largest five new positions?" he said. "Or if we combine managers: What happens if you invest in the top 15 stocks among these tiger cub firms, or the top value investors?"

Gerald Martin, a professor of finance at American University's Kogod School of Business, has spent time investigating cloning strategies in hedge fund investing.

"Imitation is the sincerest form of flattery," Martin said. "From an academic standing ... it makes sense, because why not have the best investors out there working for you. Why not have Warren Buffet as your investment manager? ... By copy-catting, you're getting the best investment manager there is."

"In the extreme, it's nothing more than indexing," he said. "Except you're indexing on managers, not industries -- managers that have made choices."

The Frustrations Of Wealth Management

At first, Jadallah conceived of his firm as a research business, but it was tough to make money from his reports.

"I had a great horse, but I was in the wrong horse race," Jadallah said. "Selling research is tough when you're selling a really new way to essentially pick managers." When you're offering a new way to invest, "People want to see the proof in the pudding," he said

That realization sent him into the asset management business, which was more scalable and showed potential customers he was invested in his own model.

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"We're eating our own dog food," he said. "And we're putting up monthly performance, doing it in an environment that's different for active investors. I'm delighted to say we're really killing it."

His AlphaClone Alternative Alpha ETF selects the top equity holdings of the top hedge fund managers, and clones them in a liquid, low-cost vehicle. Since its launch, the ALFA ETF has returned 18.87% vs. 14.32% for the S&P 500. That puts it in the top quartile of performers.

Tad Buchanan, a principal at Buchanan Investments who is also an AlphaClone client and equity investor, noted the advantages.

"The issue for the average guy, the retail investor, who has capital to invest and perhaps not enough capital -- hundreds of thousands if not millions of dollars -- that AlphaClone gives one exposure to," he said

Going Big for Less

Of course, the common man already had the ability to ride the coattails of the most successful funds. It was just a more costly endeavor.

Retail investors could go through a middle-man vehicle called a fund of funds (FOF). A hedge fund typically takes 2% of assets per year plus 20% of your profits as a fee. A fund of funds charges an additional 1% on your assets and 10% on the profits -- meaning you start by parting with 3% of your assets and 30% of your profits.

AlphaClone cuts out the middle man and increases your profits accordingly. In fact, the gross expense ratio for the ALFA ETF is just 0.95% And if you hold onto your investment in the ETF for a year or more, you have the tax advantage of long-term capital gains treatment.

Further, where funds of funds often have restrictions about when investors can take their money off the table, AlphaClone is liquid.

AlphaClone also has an interactive dynamic hedge that softens the blow when your portfolio starts heading lower.

"It's not as nimble as an equity manager or a portfolio manager," Buchanan said, "but [it gives investors] access to a hedge without the big fees and the lock-ups, there's no catch. You're picking teams and cloning your portfolios."

It may not be a 100% certain way to profit -- no investment is -- but drafting the stars onto your own team sure beats passively watching your assets lose.