RBC’s Hedge Fund Index

Throwing down the gauntlet

Stuart Fieldhouse

RBC Alternative Assets Group has launched the RBC Hedge 250 Index, the latest addition to the broad array of hedge fund-based indexes being made available to investors. Described by RBC as "a broadly diversified and representative investable hedge fund index," the RBC 250 is composed of 250 individual funds, up to six times greater than the number of funds referenced by other investable indices. Funds represented in the new index are thought to capture approximately 20% of the total hedge fund assets under management, including many firms that are now closed to new investors, have longer lock-up provisions, or have recently launched operations.

"We've been investing in hedge funds since 1997, and have invested with thousands of managers," Winston Ho, co-creator of the index and co-head of the Alternative Assets Group at RBC said. "We found that the performance of the existing investable indexes was consistently worse, to the tune of 100 basis points per year. We felt they were compromising on being representative, and we felt we could do a better job.

"We've been running the index over nine months or so, and our performance has been closer to the non-investables," Ho said. "People want passive exposure, but they don't want to sacrifice on performance."

For the past 10 years, RBC's Alternative Asset Group has created structured products referencing portfolios of hedge funds. It currently holds investments in over 1000 hedge funds, representing assets in excess of $10 billion. The Canadian bank has developed a proprietary methodology which assesses potential index constituents based on 20 criteria. With between 250-255 funds in the index at any one time, Ho reckons the RBC offering has six times more funds than some other groups.

The RBC 250 Index employs a screening process to identify component funds from a universe of 4700 funds. The index follows a set of rules to direct and adjust its composition over time. Unlike other investable hedge fund indices, it references actual hedge funds and not separately-managed accounts. This makes it possible to include a wide range of funds and managers, and not just those that are the most liquid and accessible.

"We believe our proprietary process results in an index which is more representative than other investable indices, and as a result, will more accurately reflect the industry's returns," Ho said. "So far, this conclusion has been firmly supported by its performance."

Since its inception in July 2005, the RBC Hedge 250 Index has had a net return of approximately 9.44% (to end of February 2006). In comparison, over the same period, the non-investable indices have averaged 10%, while the other investable indices have averaged 5.5%.

According to Ho, given the way the RBC index functions, he strongly believes it has a persistent tracking advantage over the other investable indices and therefore constitutes a valuable investable benchmark. The launch of the index has already created considerable interest in the investing community on both sides of the Atlantic: "We're a Canadian bank with limited distribution capability, but we are finding people are hunting us out because they hear about this thing. It serves a part of the market that is not being very well served right now."

The initial weighting of the RBC Hedge 250 Index is based upon a determination of each strategy's representation in the total hedge fund universe. The number of funds representing each strategy is proportional to the weighting of that strategy. Adjustments may be made monthly to the weightings of the strategies and the funds. RBC says it will report the index performance on a monthly basis, along with intra-month estimates. The rules governing the operation of the index, along with performance figures, are available via a dedicated website (see below for URL). A suite of products linked to the index will be available on a private placement basis to qualified purchasers. There may also be privately offered investment vehicles established by the bank's distribution partners in the future.