There is an increasing appetite among hedge funds to enter the ETF market with their own strategies, according to white-label ETF issuers.
At first glance, the ETF vehicle might seem at odds with the typically aggressively managed and higher-risk hedge fund structure, but the growth of the active ETF market in Europe along with the wrapper’s liquidity benefits are pivoting hedge funds towards the structure.
“We are increasingly seeing interest from the hedge funds,” Paul Heffernan, CEO of Waystone ETFs, a white-label ETF issuer, told ETF Stream.
Heffernan explained the firm is seeing many hedge funds replicate the same strategy and wrapping it in UCITS ETF format, with motivations stemming from the vehicle’s liquidity benefits.
“There has been an evolution in liquidity that hedge funds offer investors. Some 20 years ago, hedging funds only offered monthly liquidity, however, since around 2010, we saw many of the same hedge fund managers adapt their strategies to enter the European market and comply with UCITS rules.
“As a result, they introduced daily dealing funds, thereby providing investors with a more frequent liquidity option.”
White-label ETF issuer HANetf has also seen an increase in demand from hedge fund managers, though noted this remains a small portion of their overall clients.
Hector McNeil, co-founder and co-CEO of HANetf, said: “Obviously, a huge constraint to the hedge world is liquidity of the underlying asset and the ability to create or redeem on it.”
Alongside liquidity benefits, Heffernan and McNeil see the growth of the active ETF market in Europe as a catalyst for hedge fund managers looking to launch ETFs.
“An active strategy is more akin to that of the hedge fund world,” McNeil said.
Echoing his views, Lisa Mantil, global head of Goldman Sachs ETF Accelerator, an ETF service provider, said: “As ETFs continue to gain traction, particularly actively managed ETFs, we have seen increased interest among other institutional clients like hedge funds…to deliver their investment strategies within the ETF wrapper because of the advantages the ETF structure provides including greater transparency, tradability, and tax efficiency.
“As active ETFs continue to grow in popularity, so does the opportunity cost of not being in the space. This is something we have increasingly heard from clients.”
Speaking more specifically about the types of ETFs hedge fund managers want to launch, Heffernan said there are instances when the strategies are not as easily restructured into a UCITS ETF.
This means hedge funds have to engineer the portfolios in a different way to meet diversification rules under the UCITS framework.
On the flip side, it could be argued that a hedge fund manager might be reluctant to directly launch their hedge funds in a UCITS format due to making their “high alpha” strategies transparent.
Heffernan said the need for transparency might “dissuade some managers”, however, “providing portfolio transparency also applies to the active mutual fund manager, not just a hedge fund”.
“When we talk to asset managers, mutual funds and hedge funds, they have no issues with transparency,” he added.
“The reason they are comfortable with transparency is they are only disclosing the output. They are not disclosing the methodology for how they construct their portfolio.”
To this point, McNeil added: “In the fixed income world, hedge fund managers are more comfortable with transparency because it is a lot harder to replicate and because the universe is so much broader. The equity world is more paranoid from that perspective.”
McNeil also noted that the booming success of the active market in the US has made fund managers much more at ease with transparency than they were just three years ago, leading to a broader change in how hedge fund managers approach transparency.
Looking forward, as the expansion of active ETFs starts to mirror trends observed in the US, the European market might see a continued uptick in ETF launches from hedge funds.