Exchange traded funds (ETFs) have done wonders for investors when it comes to portfolio construction. Not only have ETFs become the de-facto building blocks for many core asset classes, their usage has moved into more esoteric asset classes and strategies. Today, you can find everything from preferred stock to commodities tucked inside an ETF.
And soon you may find hedge funds.
Thanks to a recent buyout by hedge fund manager Clough Capital, hedge funds and their strategies may be coming to an ETF near you. While alternatives have long been ETF staples, the buyout and the rise of active ETFs could be a game changer for the industry. It will reduce costs and potentially put hedge funds into the hands of the masses.
Clough’s Purchase
The story of Clough Capital and ETFs is an interesting one. Founded by former Merrill Lynch strategists back in 2000, Clough Capital has about $1.3 billion in assets under management. Much of that is in so-called alternative strategies across the public and private markets. This includes traditional hedge funds, separately managed accounts, and a few closed-end funds such as the Clough Global Opportunities Fund.
And now that includes ETFs.
Back in 2020, former long-tenured Clough manager, Vincent Lorusso Jr., left the firm to start ETF company Changebridge Capital. The firm launched two active ETFs using a non-transparent structure. This kept the secret sauce, well, secret. Those two funds focused on fundamental equity research and long/short strategies.
Now, those ETFs and Lorusso have come home to roost.
Back at the beginning of the fall, Clough announced that it was buying Changebridge and rebranded its two ETFs under the Clough name. The Clough Select Equity ETF (CBSE) and Clough Long/Short Equity ETF (CBLS) will now be part of the Clough family.
The Buyout Has Significance
Alternatives and so-called hedge fund strategies have long been ETF staples, in both the passive and active space. The wonderful thing about ETFs is that their structure allows for low-cost access to some complex asset classes, while their creation/redemption in-kind mechanism and secondary market trading allows managers to own these asset classes freely without impacting returns. To that end, everything from 130/30, dedicated short, CLOs, and other esoteric asset classes have found their way into ETFs. Here, everyone—even with smaller portfolios—can benefit from these alternatives.
The key for Clough and the potential of hedge funds in ETFs comes down to the rise of semi- and non-transparent structures.
Because of their daily trading ability and market-maker requirements, ETFs were initially required to list their holdings daily. Authorized participants need to know what they are buying when they create/redeem shares. Market makers need to know what the fund holds to keep shares tied to holdings.
But when it comes to active management—particularly hedge funds that spend millions in research and model development—keeping what makes the funds tick is paramount.
With the SEC approving new ETF structures that hide holdings, hedge funds and active management of alternatives could now have a foothold in ETFs. And given that active management can outperform in these areas versus passive index funds, this is a huge win. There are also tax benefits of using ETFs and their ability to pass-off capital gains taxes.
What’s significant about Clough’s buyout is that the dedicated hedge fund manager is making the leap into offering its strategies to ETFs. If the funds catch hold and perform well, it stands to reason that Clough could offer more of its SMA and other hedge fund strategies in ETFs. And others could follow suit. Firms like Blackstone, Blackrock, Apollo, and Ares could start migrating their alternatives line-ups into ETFs.
For investors, this could be a huge win. ETFs don’t come with many of the accredited investor requirements and lock-up periods. You could easily add a professionally managed hedge fund to your portfolio for a rock-bottom price.
Early Days
It will be interesting to see what happens with Clough’s ‘new’ alternatives and what the industry has in store. But the longer angle could be more actively managed hedge funds and alternatives making their way into ETFs. Clough may have broken the dam. For investors, that might not be a bad thing.
Alternative ETFs
These funds are selected based on their ability to tap into liquid alternative strategies and their assets under management. They are sorted by their YTD total return, which ranges from -7.5% to 16%. Their expense ratio ranges from 0.50% to 1.41%, while they have AUMs of $159M to $950M. They are currently yielding between 0% and 7.9%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| FTLS | First Trust Long/Short Equity ETF | $730M | 15.8% | 1.54% | 1.41% | ETF | Yes |
| WTMF | WisdomTree Managed Futures Strategy Fund | $159M | 10.8% | 4.41% | 0.65% | ETF | Yes |
| QAI | IQ Hedge Multi-Strategy Tracker ETF | $612M | 8.1% | 1.85% | 1% | ETF | No |
| FMF | First Trust Managed Futures Strategy Fund | $164M | 1.6% | 2.52% | 0.95% | ETF | Yes |
| RLY | SPDR SSgA Multi-Asset Real Return ETF | $517M | -0.7% | 5.54% | 0.50% | ETF | No |
| MNA | IQ Merger Arbitrage ETF | $467M | -1.4% | 0% | 0.77% | ETF | No |
| DBMF | iMGP DBi Managed Futures Strategy ETF | $949M | -7.5% | 7.91% | 0.85% | ETF | Yes |
The Bottom Line
Clough Capital’s buyout of an alternative ETFs issuer could set the stage for future hedge fund ETFs. Thanks to the rise of non-transparent structures, the industry could grow huge as investors take advantage of ETFs’ lower costs and tax advantages, which are perfect for hedge fund management.