The landscape of alternative investments is undergoing a significant transformation, with a growing focus on making sophisticated strategies more accessible and cost-effective for a broader range of investors. Leading hedge funds have long been recognized for their potential to generate substantial returns through active management, yet their exclusivity and high fees have historically limited participation to a select few. In this evolving environment, Bob Elliott, CEO of Unlimited, has introduced a novel approach with the HFND ETF, aiming to deliver hedge fund-like returns at a fraction of the cost and with enhanced accessibility.
Elliott, a veteran of the investment world with nearly 15 years at Bridgewater Associates, a pioneer in systematic macro investing, brings a deep understanding of complex market dynamics to his current venture. His career began at Bridgewater when it was a nascent firm, and he was instrumental in its growth, developing a comprehensive grasp of systematic investment strategies across various asset classes. This foundational experience in rigorous, data-driven analysis underpins his belief that alternative ETFs can indeed outperform traditional hedge funds, especially when accounting for fees and other associated costs.
The Allure and Accessibility of Hedge Fund Strategies
The term "hedge fund" often conjures an image of an exclusive club, a realm of sophisticated investors employing complex strategies to navigate market volatility. For many, understanding the inner workings of these funds has remained elusive. Elliott, however, seeks to demystify this world by leveraging technology and a systematic approach.
"What folks who are often pursuing these alternative strategies, and I’d say in particular in macro, is this understanding of how the whole system works," Elliott explained in a recent interview. "It’s not surprising. I come from a pure sciences background, which is really focused on how do you understand the totality of, you know, a biological system. You could think about markets and economies as just a different type of system."
This perspective highlights a core tenet of macro investing: identifying and quantifying the intricate cause-and-effect relationships that drive economic and market movements. Elliott emphasizes that macroeconomics, as taught in traditional academic settings, often diverges from the practical realities of market behavior. The true edge, he suggests, lies in understanding the intuitive drivers and then systematically quantifying these linkages.
Systemization: The Key to Discipline and Edge
The process of systemization, according to Elliott, is essentially about quantifying these intuitive understandings and applying them repeatedly and with discipline. This approach offers a significant advantage over purely discretionary investing, which can be susceptible to emotional biases and overreactions to incremental information.
"The biggest benefit of systemization is quantification and discipline," Elliott stated. "Often investors can challenge. If you’re a discretionary investor, it can be very challenging to basically pursue, keep true to your investment strategy because you’re always being influenced by the incremental information that’s out there."
The discipline inherent in systematic strategies helps synthesize vast amounts of information and execute a pre-defined plan, mitigating the risks of emotional decision-making. Elliott likens the probabilistic nature of macro investing to being a skilled blackjack player. Even the best investors are not always right; they might win 55% of their bets and lose 45%. However, when applied across a broad spectrum of markets and consistently over time, this slight edge can lead to significant outperformance.
Navigating Market Complexities: Beyond the Simple Linkage
While simple linkages, such as inflation impacting bond yields, are understood, the real challenge lies in predicting the reactions to these initial movements. Policy responses from central banks, market pricing in of anticipated events, and the cascading effects of these actions create a complex web of interactions. Elliott acknowledges this complexity, stating that the goal is not to achieve perfect foresight but to gain an "edge in predicting what the various people involved in the markets will do."
This predictive edge is often gained by understanding the motivations and constraints of key market participants, including central banks. Elliott points out that central bank actions are not arbitrary but are typically a function of incoming economic data and pre-defined decision rules. By analyzing these inputs and their corresponding response functions, investors can develop a more accurate prediction of future policy moves.
The Hedge Fund Industry: Performance and Challenges in 2022
The year 2022 presented a challenging market environment, with traditional 60/40 portfolios experiencing significant drawdowns. In contrast, many alternative investment sectors demonstrated resilience and even strong performance. Hedge funds, in aggregate, also performed commendably.
"The hedge fund industry in aggregate did pretty well in a challenging market environment," Elliott noted. "At its, you know, 60/40, depending on exactly how you price it, was maybe down between 15 and 20%. Hedge fund performance before you consider the fees that they may charge… the hedge funds in aggregate were basically flat, down maybe one or two, you know, a couple of percent over the course of 2022."
This performance, even before accounting for fees, highlights the effectiveness of hedge fund strategies in capital preservation during turbulent times. Strategies like equity long-short, while underperforming relative to cash, still delivered significant alpha compared to passive market benchmarks. This underscores the defensive capabilities of hedge funds in managing risk, reducing beta exposure, and seeking value opportunities.
However, the hedge fund industry faces several pain points for investors outside of the institutional sphere. High fees, typically ranging from 300 to 400 basis points annually, can significantly erode returns. Furthermore, the traditional limited partnership (LP) structure often leads to tax inefficiencies, with annual distributions taxed at marginal income rates. For smaller-scale investors, gaining access to a diversified portfolio of top-tier hedge funds is also a challenge, often necessitating investment in funds of funds which can further layer on fees. The administrative burden of paperwork, including K-1s, adds another layer of complexity.
The Unlimited HFND ETF: A New Paradigm
It is in response to these challenges that Unlimited has launched the HFND ETF, the Unlimited HFND Multi-Strategy Return Tracker ETF. The fund’s objective is to replicate the gross-of-fees returns of the hedge fund industry while offering a more accessible and cost-effective structure.
"The first pain point is that hedge fund fees are very high," Elliott explained. "So, if you take the hedge fund industry as a whole, they’re typically adding between 300 and 400 basis points of fees on an annual basis."
The HFND ETF aims to address this by leveraging proprietary hedge fund strategies developed with the assistance of modern machine learning techniques. By analyzing the positions and exposures of hedge fund managers in near real-time, the ETF can construct long and short positions in various index products, packaging these into an exchange-traded fund wrapper.
"The idea is, you know, if we can create… What investors care about in the end is their post fee, you know, their net of fee post-tax return, right? That’s what they really care about," Elliott emphasized. "And so, by using technology, our replication of these strategies is imperfect because it’s naturally… you know, because we can’t perfectly replicate investing in 5,000 hedge funds. But if we can do a pretty good job of that to replicate the strategies…"
This technologically driven approach allows Unlimited to offer its product at approximately a quarter of the management fee typically charged by hedge funds. Moreover, its ETF structure provides greater tax efficiency compared to traditional LP structures. The fund also eliminates the minimum investment thresholds and extensive paperwork associated with direct hedge fund investments, making it accessible to individual investors and financial advisors alike.
The Rise of Actively Managed ETFs and the Future of Alternatives
The launch of HFND signifies a broader trend in the investment management industry: the increasing acceptance and sophistication of actively managed ETFs. While early iterations of actively managed ETFs faced skepticism, recent regulatory evolutions and investor demand for more complex strategies within the ETF wrapper have paved the way for innovation.
"ETFs, you know, in the past were seen very much as the way to run very low cost, you know, liquid indexing products," Elliott observed. "And increasingly investors are recognizing that you can run more sophisticated strategies than the ETF wrapper."
These regulatory changes, implemented around 2020-2021, have allowed managers to implement more complex strategies while adhering to institutional-quality risk controls. This has opened the door for products like HFND, which combine sophisticated investment approaches with the inherent benefits of the ETF structure: liquidity, transparency, tax efficiency, and ease of execution.
Looking ahead, Elliott anticipates a rationalization of fees across the investment management industry, particularly in an environment of potentially lower returns. He believes that the skill of the investor relative to the fees charged will come under increasing scrutiny.
"There are absolutely hedge funds that deserve the fees that they charge," Elliott stated. "But that is also a relatively small portion of the hedge fund industry, and it’s a part of the hedge fund industry that’s very hard to access for the vast majority of investors… For the rest of the world, you know, who aren’t those big, sophisticated institutions, we’re gonna have a real reckoning of the rest of the hedge fund industry, where frankly, the vast majority of the hedge fund industry does not justify its fees."
He predicts a bifurcation in the hedge fund industry, with capital flowing towards truly differentiated alpha generators accessible only to institutional investors, and a significant portion of capital shifting towards sophisticated replication strategies offered in investor-friendly structures like ETFs. This transition, he argues, will ultimately benefit investors by providing access to advanced strategies that are diversified, consistent, and significantly lower in cost.
For investors and financial advisors seeking to learn more about Unlimited and the HFND ETF, the company’s website, unlimitedfunds.com, offers detailed information and ongoing commentary on investment topics. Bob Elliott also maintains an active presence on Twitter, @BobEUnlimited, where he regularly discusses macroeconomic trends and investment insights, further democratizing access to sophisticated financial knowledge.
