Hedge fund replication

What it means

Reproducing hedge fund returns using liquid instruments and factor exposures, rather than by paying for the funds themselves.

The exam angle

Works to the extent returns come from factors rather than skill. The residual is what the fee was supposedly buying.

Where it appears in the syllabus

• Risk & Investment ManagementFRM Part II · exam weight 15% · Factor theory, risk budgeting, attribution, hedge funds, illiquid assets.

Related terms

• Arbitrage pricing theoryA model deriving expected returns from exposures to multiple systematic factors, assuming no arbitrage rather than a…
• Factor investingBuilding portfolios around systematic return drivers — value, size, momentum, quality, low volatility — rather than…
• Liquidity-adjusted VaRVaR extended to include the cost of closing the position — the bid–ask spread and the market impact of exiting at size.
• Marginal VaRThe change in portfolio VaR from a small increase in one position — the position’s contribution to total risk at the…
• Multifactor modelA model explaining returns by exposure to several systematic factors rather than to the market alone.
• Performance attributionDecomposing a portfolio’s return relative to its benchmark into the decisions that produced it — typically allocation,…