Can Nordic Hedge Fund Returns be Replicated? - A Factor Replication of Nordic Hedge Fund Returns

Abstract: Research on the topic of replicating hedge fund returns has been around for more than a decade and has shown that a substantial portion of hedge fund returns can be attributed to a collection of risk premia of market returns, rather than any superior management skills of hedge fund managers. Focusing on Nordic hedge fund returns, we create replicating portfolios, or clones, to explore the low-cost, transparent, liquid and scalable world of replication. Using monthly returns data for 102 Nordic hedge funds in the Hedgenordic (NHX) Index from 2005 and to 2010, we attempt to replicate the returns using two linear factor models. We find that the performance of the linear clones captures a significant portion of the hedge fund returns and risk characteristics, in line with previous research. This point to the conclusion that hedge fund returns can to a large extent be replicated with a simple linear factor model, with performance of the clones in line with that of the underlying funds.