Mutual Fund Replication–Death of Closet Indexers?

Mutual Fund Replication–Death of Closet Indexers?

December 23, 2014 Uncategorized
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(Last Updated On: December 23, 2014)

Want to identify how to replicate an expensive, tax-inefficient mutual fund with ETFs?

Interactive Brokers has a pretty cool tool that does exactly that!

Check out their “Mutual Fund Replicator.”

In the example below, the IB system examines the Janus Perkins Small Cap Value Fund, highlighting that it can be synthetically replicated with a portfolio consisting of 58% SCHB and 42% PSCF.

We went ahead and tried the system out on a random large cap value fund: The Fidelity Value Discovery Fund (FVDVX).

FVDVX is a 900mm large cap value fund with 92 holdings spread across mega-cap holdings ($10B and higher).

The fees aren’t ridiculous (80bps), but the fund can be replicated with a high degree of precision by simply investing 91% in Vanguard’s Value ETF and 9% in the iShares Residential Real Estate ETF.

 

mutual fund replicate

 


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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Ryan

    They state that the tool simply finds a portfolio with the highest historical correlation to the chosen mutual fund.

    Claiming that they can replicate performance going forward is deceptive to such a great extent I would consider it malicious. No professional would ever recommend such a methodology.

    Correlations in the market are notoriously fleeting, and spurious correlations will be prevalent over such a short time period.

    There are several academic papers on replicating active manager performance. Ideally you perform a style analysis of the portfolios holdings (value, growth, sector tilts, etc…) and replicate that going forward. Such techniques are very effective at predicting future returns, but are obviously much harder to implement.

  • Ryan,

    I agree that a factor analysis breakdown would be a more effective way of “cloning” various exposures. That said, without knowing the full extent of the IB “blackbox,” based on a few random attempts at using the system, it seems to capture factor-exposures…

    We talk about a more complex way of “cloning” a mutual fund in this old post:

    http://www.alphaarchitect.com/blog/2013/09/24/identify-your-size-value-and-momentum-benchmark/#.VKH5wl4Bw

  • markot6

    Try Alpholio.com : It uses a patented methodology to create a replicating ETF portfolio in three different modes (fixed membership and weights, fixed membership and variable weights, and variable membership and weights).