On the Market-Timing Ability of Factor-BasedHedge Fund Clones

Abstract

Hedge fund clones systematically mimic features of hedge fund returns. The author constructs clones of hedge fund indexes using several factor models and estimation intervals. Exposures of clones to asset and style factors vary over time, and excess returns from tactical exposure adjustments (i.e., market timing) are a potentially important source of returns. Clone market-timing ability is measured three ways: a regression on the factors used in construction; a multi-time scale attribution model; and directly from clone exposures. The author does not find evidence of market-timing ability in clones. Because the target hedge fund indexes do not exhibit market-timing ability—possibly an artifact of hedge funds’ security-selection ability—he also constructs clones of CommodityTradingAdvisor and Macro indexes that display timing ability. Clones of these latter indexes generally do not exhibit market-timing ability either. Lagged data and optionlike hedge fund strategies pose challenges to market timing in factor-based clones.