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Hedge fund replication and FX: If you can't beat them, join them

Merrill Lynch is the latest to replicate hedge fund returns, this time in FX, reports Nick Fitzpatrick.

This article appears courtesy of Global Investor.

The concept of synthetic hedge funds, whereby hedge fund returns are replicated, has been extended to the FX asset class.

Hedge fund replication goes back to at least 2005 when in June of that year Harry Kat and Helder Palaro, of the Cass Business School in London, issued a paper (Hedge Fund Returns: You Can Make Them Yourself!) in which they revealed that by dynamically trading futures in much the same way as investment banks hedge their OTC option positions it is possible to generate returns that are statistically very similar to the returns generated by hedge funds. This, of course, is without "any of the usual drawbacks" of transparency or style drift problems, and without paying "over-the-top" management fees, they said.

"Hedge fund returns may be different, but they are certainly not unique," they added.

Now Merrill Lynch, the bank, has launched the ML FX CLONE model to replicate hedge fund foreign exchange strategies, saying this will help investors to better understand and ultimately access the FX markets with greater ease and at lower cost.

It is designed to replicate the most widely-used FX investment styles followed by active portfolio managers, and it is being aimed at investors who wish to gain exposure to FX as an asset class or who wish to hedge underlying exposure to currency funds.

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