Replication strategies have gained in popularity as investors increasingly are looking to capture the benefits of hedge fund investing while avoiding their associated high fees, opacity of process and holdings, and low levels of liquidity.

This is according to a study released by Gregg S Fisher (pictured), president and chief investment officer of independent investment management firm Gerstein Fisher, and Nicolas PB Bollen, the E Bronson Ingram Professor of Finance at the Owen Graduate School of Management, Vanderbilt University, called "Send in the Clones? Hedge Fund Replication Using Futures Contracts".

In their study, Fisher and Bollen sought to replicate a series of Dow Jones Credit Suisse hedge fund indexes using five liquid futures contracts to permit low-cost, liquid exposure to most major asset classes. They then performed a series of rolling-window regressions, each of which yielded a set of allocation weights that were used to construct a clone portfolio. They varied implementation details such as estimation window length to determine their impact on clone performance.

The results of the study were mixed: while the clone portfolios, on the whole, were highly correlated with their underlying indices, their Sharpe ratios were generally inferior to those of the hedge fund indexes and annual returns were often below those of the indexes.

"The only way clones can add value is by capturing the factor timing activity of the hedge funds they are attempting to replicate. Our study estimates the market timing ability of both the indexes and their clones and finds little evidence it exists," says Bollen.

Fisher adds: "While our results point to the clones' inferiority from a risk/return standpoint, our replication procedure has other practical applications."

As an example, the paper cites the rolling window factor model regressions' ability to remove systematic risk exposure from strategies such as portable alpha, which could aid in risk budgeting for institutional investors.