After exploring the benefits of Long/Short Equity exposure and its potential for navigating the mid- to late-2020s investment landscape in Part 1, we now turn to analyzing the performance of key Long/Short Equity Hedge Fund Indices and the common challenges they face. Additionally, we'll examine the typical cost structures associated with these hedge funds.

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Performance of Long/Short Equity Hedge Fund Indices

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Of course many Long/Short Equity Hedge Funds Indices exists, but in this article, we focus on three prominent indices from Eurekahedge and Barclay:

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1. ‍Eurekahedge Long Short Equities Hedge Fund Index: This equally weighted index comprises 1’309 funds, making it non-investable and challenging to replicate due to its vast number of constituents.‍
2. Eurekahedge Long Short Equities Asset Weighted Index: This index is a flagship asset weighted index of 631 constituent funds, emphasizing larger assets.‍
3. Barclay Equity Long Short Index: This directional strategy involves equity investing on both long and short sides, allowing managers to shift between value and growth stocks, various market caps, and net positions.

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For those interested in further free (or at least partially free) resources for Hedge Fund Indices, here is a non exhaustive list:

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1. ‍Bloomberg Equity Long/Short Hedge Fund Index‍
2. Long/Short Equity Morningstar Category‍
3. Hedge fund performance by strategy Aurum‍
4. Nordic Hedge Index‍
5. IASG‍
6. Absolute Hedge (sadly paying since a few weeks)

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It is important to mention that hedge fund indices often suffer from selection, backfill, and survivorship biases, potentially misrepresenting actual investor performance (for further information please refer to: Which hedge fund indices suit best for investors?).

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Fund of Hedge Funds (FoHF) indices, such as the Eurekahedge Long Short Equities Fund of Funds Index, mitigate these biases in performance reporting by indirectly including non-reporting funds’ returns and reflecting losses from liquidated funds.

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Thus, FoHF indices offer a more accurate approximation of average hedge fund returns. Comparisons between hedge fund indices and FoHF indices reveal that FoHF indices typically report lower returns, correcting for biases that tend to inflate performance.

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Let us analyze how these four different indices have performed historically and how they compare to the S&P 500 Total Return (Figure 1 and 2).

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Figure 1: Performance chart net of fees from 2004-12-31 to 2024-05-31

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Figure 2: Statistics table net of fees from 2004-12-31 to 2024-05-31

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Upon reviewing these indices against the S&P 500 Total Return, our key observations include:

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1. Post-Fee Performance: Long/Short Equity Hedge Funds often struggle to outperform and generate alpha compared to the S&P 500 TR after fees.
2. Risk Management: They are effective at managing risk, with lower volatility and drawdowns than the S&P 500 TR, notably the Barclay Equity Long Short Index.
3. Eurekahedge Long Short Equities Hedge Fund Index’s performance stands out from the others. Here a few probable reasons: a) It tracks the performance of a portfolio investing the same amount in each Long/Short hedge fund and thus suffers most from the biases mentioned above. b) Being an equally-weighted index it might put more weights on small hedge funds which empirically tend to have delivered better returns than large ones.
4. Small can be beautiful: Large funds do not consistently outperform smaller and mid-sized funds. Indeed, the FoHF index, despite the additional layer of fees and the reduced susceptibility to biases, tends to deliver slightly better performance than the Asset Weighted Index which heavily overweight large hedge funds. Given that FoHFs are usually also more heavily invested in large hedge funds, this would suggest that their superior performance primarily comes from allocations to small and mid-sized hedge funds.

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While Long/Short Equity Hedge Funds are good at managing risk and reducing drawdowns, their high fees may diminish their ability to deliver significant alpha. Hence, it could be that they are just too expensive for what they offer. Next, we'll examine their standard fee structures to further evaluate their value proposition.

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Fee Structure of Long/Short Equity Hedge Funds

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As can be seen in Figure 3, the average fees for Long/Short Equity Hedge Funds are notably high, with an average management fee of 1.47% and an average performance fee of 19.01%.

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Figure 3: Average terms and conditions for various Long/Short Equity Hedge funds. Source: Aurum

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To better understand the impact of these fees, we can estimate the gross performance of various hedge fund indices (see Figure 4 and 5).

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Figure 4: Graphical comparison of gross and net performance of four different Long/Short Equity Indices from 2004-12-31 to 2024-05-31

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Figure 5: Table comparing gross and net performance of four different Long/Short Equity Indices from 2004-12-31 to 2024-05-31

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Long/Short Equity Hedge Funds seem able to consistently generate positive alpha before fees, as reflected in their information ratios. The Fund of Funds Index, offering a less biased estimate of typical returns, reports an annualized alpha near 3% with an information ratio close to 0.5.

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Recognizing the alpha potential of the Long/Short Equity approach compared to passive strategies, Alquant developed a quantitative methodology to replicate or achieve similar returns to those of Long/Short Equity Hedge Fund indices.

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How does Alquant replicate such indices?

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Alquant’s replication strategy is founded on the concept that a Long-Short Equity allocation, diversified across multiple hedge funds as typically implemented by asset allocators, can be effectively modeled by a dynamic beta exposure.

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Indeed, fund managers typically engage in shorting certain stocks while going long on others, guided by both bottom-up and top-down research, which allows them to adjust their overall exposure based on macroeconomic conditions and specific opportunities.

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As such a diversified Long-Short Equity allocation aggregates various investment strategies, smoothing individual bets and resulting in a dynamic beta that serves as the main source of alpha. This beta fluctuates, typically higher in favorable market conditions and lower during downturns, averaging between 0.2 and 0.5 depending on the directionality or market neutrality of the underlying funds.

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After extensive research, Alquant developed the Leonteq Alquant Long-Short US Equity Index (Ticker: ALTQUSLS Index) to closely replicate the dynamic beta exposure of Long-Short Equity Hedge Fund Indices. Alquant leverages its risk indicators (live since October 2018) and adapts exposure to S&P 500 futures to mirror these dynamics. Consequently, the Leonteq Alquant Long-Short US Equity Index closely mimics the behavior of Long-Short Equity Hedge Fund Indices while maintaining transparency and efficiency.

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In January 2024, Leonteq launched an ETP+ on the Leonteq Alquant Long-Short US Equity Index (Ticker AQLS), offering a fully-collateralized vehicle that tracks the underlying index for a 1% all-in fee with no performance fee. This innovation provides investors access to Long-Short Equity Hedge Fund strategies with greater transparency and fairer conditions compared to traditional hedge funds.

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AQLS isn't cheaper; it's simply fairer

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Our product's stronger performance is driven by a more attractive fee structure and efficient operations. For example, avoiding the need to short individual stocks significantly reduces borrower fees. These advantages make our offering particularly appealing to investors seeking efficient and fair replication of Long-Short Equity Hedge Fund exposure.

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AQLS isn't just about being cheaper; it's about being fairer. We believe that AQLS shares the generated alpha from Long/Short Equity strategies more fairly with the end investors who put their capital at risk.

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To conclude this section, we compare the performance of the Leonteq Alquant Long-Short US Equity Index, after applying AQLS fees, to the gross and net performance of the Barclay Equity Long Short Index and the Eurekahedge Long Short Equities Hedge Fund Index since the launch of Alquant's indicators on October 22, 2018 (Figure 6 and 7).

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Figure 6: Table comparing the statistics of the  L/S Leonteq Index net of fees to the ones of the S&P 500 TR, the Barclay Equity Long Short Index gross of fees and net of fees from October 22, 2018 to May 31, 2024. The L/S Leonteq Index net of fees represents the performance of the Leonteq Alquant Long-Short US Equity Index net of AQLS’s fees since the launch of Alquant's indicators on October 22, 2018 (out-of-sample). After monitoring our indicators, Leonteq decided to launch the ALTQUSLS Index in early December 2023. The product was officially launched on January 12, 2024, and began trading on the SIX on February 23, 2024.

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Figure 7: Table comparing the statistics of the  L/S Leonteq Index net of fees to the ones of the S&P 500 TR, the Eurekahedge Long Short Equities Hedge Fund Index gross of fees and net of fees from October 22, 2018 to May 31, 2024. The L/S Leonteq Index net of fees represents the performance of the Leonteq Alquant Long-Short US Equity Index net of AQLS’s fees since the launch of Alquant's indicators on October 22, 2018 (out-of-sample). After monitoring our indicators, Leonteq decided to launch the ALTQUSLS Index in early December 2023. The product was officially launched on January 12, 2024, and began trading on the SIX on February 23, 2024.

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Conclusion

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Long/Short Equity hedge funds have demonstrated their risk-management strengths and alpha-generating potential. However, high fees often reduce net returns, making it difficult to justify their costs.

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Alquant's approach of replicating Long/Short Equity strategies via the Leonteq Alquant Long-Short US Equity Index (ALTQUSLS Index) offers a compelling alternative. Indeed, by offering lower fees and greater transparency, such innovative products replicate the dynamic beta exposure of traditional Long/Short equity hedge funds, while sharing the alpha generated more equitably with investors. As the landscape evolves, this fairer approach may redefine the value proposition of Long/Short Equity strategies in the market.

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The launch of ETP+ on this index democratizes access to Long/Short Equity strategies, guaranteeing efficiency and fairness. Indeed, our ETP+ (Ticker: AQLS) on the Leonteq Alquant Long-Short US Equity Index (Index Ticker: ALTQUSLS) is traded on the SIX Swiss Exchange, fully collateralized, and accessible to all investors with no minimum investment requirement.

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Disclaimer

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‍This content is advertising material. This content as well as all information displayed on any of Alquant’s websites does not constitute investment advice or recommendation, and shall not be construed as a solicitation or an offer for sale or purchase of any products, to effect any transactions or to conclude any legal act of any kind whatsoever. Past performance is not a guide to future performance.

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