Hedge fund data provider HFR is at an advanced stage of working with one of the large global derivatives exchanges to develop a new investment product, the HFRI-I futures contract, a contract based on the HFRI-I Fund Weighted Composite Investable Index. The firm writes that once launched, this will be an industry first.
The thinking behind the contract is that allocating to individual hedge funds requires extensive research and substantial capital which can be tied up for long periods. Marc E Denogent, HFR Asset Management’s Managing Director says: “When people allocate to hedge funds, they often have a considerable time lag between due diligence to the actual allocation. This could be six months to a year or a year and a half. They tend to keep an allocation to cash but a more efficient way of allocating the money is to use the futures contract and dial up or down the exposure effectively while only posting a 10 per cent initial margin.”
Denogent explains that HFR first looked at creating a contract some 10 years ago but it was technically not possible to implement. Those issues have been resolved in the past six months. Their research includes a survey asking all allocators to hedge funds, from wealth managers to high net worth individual investors of their feelings on the product.
Denogent reports that reaction so far has been positive. The new contract should be available from the first quarter of next year and will be called the HFRI-I Fund Weighted Composite Investable Index. “We needed funds that were in the more liquid alternatives space,” Denogent says. “The HFRI is a fund weighted index based on over 2,000 offshore hedge funds. When people look and compare the indices, the risk and return profile between the HFRI Fund Weighted Composite Index and the investable HFRI-I Fund Weighted Composite Investable Index has a correlation of 93 per cent and performance of 4.02 per cent since July 2007.”
Denogent also announced that the firm is working on launching an ETF based on the index.
The 10 per cent initial margin on the HFRI-I futures contract allows the average institutional hedge fund portfolio to retain 100 per cent exposure to hedge funds while freeing up cash balances to pursue other opportunities, facilitate rebalancing or improve liquidity.
The firm writes that the HFRI-I futures contract will enable investors to leverage their exposures to hedge funds up or down to coincide with their level of risk tolerance and corresponding return objectives. For example, if equity volatility is 15 per cent-20 per cent, while hedge fund volatility is nearer to 5 per cent-10 per cent, a futures contract on the HFRI-I would enable an investor to allocate two to three times the exposure to match.
While HFR cannot at the moment name the exchange involved in its new contract, it can confirm that the contract will be cleared through a clearing house, thereby reducing counterparty risk.
More information and an opportunity to take part in the potential user’s survey for the new contract is available here.
