So, for example, a non-’40 Act investment employing triple leverage (borrowing funds to invest three times its net assets) may be referred to as an exchange-traded fund, but strictly speaking, it is an exchange-traded product, not an ETF. This type of alternative fund may be registered under the Securities Act of 1933, but it won’t offer investors the same protections as those with ’40 Act registration. Some strategies that invest in alternative asset classes like commodities and currencies can be registered under the ’40 Act. This protection—as well as the ETF structure itself—can be particularly meaningful these investors:
• ’40 Act alternative ETFs help protect investors from the excessive use of leverage, short selling and over-concentration that can be part of non-’40 Act alternative investments.
• Traditional alternative strategies, like hedge funds, typically do not disclose their holdings to investors, whereas all ETFs disclose their holdings on a daily basis.
• The structure may help reduce some of the risks of these asset classes by providing a diversified fund approach.
• Although some alternative assets or markets cannot be converted to cash on a daily basis, ETF shares can be sold at any time during a business day.
• Where many traditional, non-ETF alternative strategies have strict investor qualifications, any investor can buy shares in any ETF.
• Most traditional, non-ETF alternative strategies have minimum investment requirements that can be prohibitive, to say the least. As ETFs have no minimum requirements, an investor can purchase a single share if they so desire.
• It is often costly and risky to purchase alternative assets like commodities and currencies on your own. Though subject to trading fees, ETFs typically have low management fees and can be quite cost effective.
• Traditional non-ETF alternative investments can have complicated tax consequences. For example, hedge fund investors must wait for their K-1 (a partnership tax form that outlines the gains or losses of the alternative investment) in order to file their taxes. ETFs have no such requirement—and may actually be used to help manage taxes through tax-loss harvesting or other tax management strategies.
When considering different exchange-traded investment options, take into account whether the fund offers the protections of the Investment Company Act of 1940.
This post was republished with permission from the WisdomTree blog.