“…the most common type of hedge-fund cloning, known as the factor model approach, works: Firms analyze a few years’ worth of hedge-fund returns, often using data from hedge-fund indexes. The firms then essentially reverse-engineer those returns, using complex mathematical models to create a portfolio of easily traded investments that would have delivered the hedge funds’ performance over that period.
That group of investments becomes the clone’s portfolio for the next month. Then the process is repeated, typically each month, and the portfolio is revised.”
Like the brownies on ATHF, it is doubtful that the clones will be able to match the real thing:
“Andrew Lo…whose research helped to spark clone products, says he has found that the clones will capture only about 40% of hedge-fund returns. One reason: Some hedge funds are especially hard to mimic, such as those that try to profit from events such as corporate bankruptcies, because they often hold hard-to-trade securities that are off-limits to clones.”