With markets hovering around all-time highs, alternative exchange traded funds that help diversify risk and volatility could begin to attract more attention, but market observers require more education.
“Should the average investor have exposure to alternative investments? Yes and no,” Douglas Kobak, certified financial planner and principal of Main Line Group Wealth Management, said in a CNBC article. “‘Alternatives’ is such a nebulous word, and it encompasses so many strategies.”
According to Morningstar, common liquid alternative fund strategies cover bear market, multicurrency, single currency, long/short equity, market neutral, multialternative, managed futures and volatility, along with trading leveraged commodities, inverse commodities, leveraged debt, inverse debt, leveraged equity, inverse equity. [Alternative ETF Options to Diversify an Investment Portfolio]
Between 2008 and 2014, the alternative mutual funds and ETFs space expanded from 482 products to 1,569, with assets growing to $309 billion from $42.6 billion. The IQ Hedge Multi-Strategy ETF (NYSEArca: QAI) is the largest hedge fund strategy ETF, implementing various hedge fund investment styles, such as long/short equity, global macro, market neutral, event driven, fixed-income arbitrage and emerging markets.
The ProShares Morningstar Alternatives Solution ETF (NYSEArca: ALTS) and PowerShares Multi-Strategy Alternative Portfolio (NasdaqGM: LALT) are two recently launched offerings. ALTS includes exposure to long-short strategies, hedge fund replication, managed futures, global infrastructure, merger & acquisitions, private equities and Treasury spread. The actively managed LALT holds a combination of equities, along with financial future contracts, forward currency contracts and other securities. [Alternative ETF Options to Diversify an Investment Portfolio]
Additionally, ETF investors can select single styles, like the WisdomTree Managed Futures Strategy Fund (NYSEArca: WDTI), which tries to achieve a positive total return in either rising or falling markets that are uncorrelated to broad market equity and fixed-income returns through a combination of long and short positions in U.S. treasury futures, currency futures, non-deliverable currency forwards, commodity futures, commodity swaps, U.S. government and money market securities. [Liquid Alternative ETFs for a Changing Investment Landscape]
Due to the multitude of investment strategies available, advisors and clients should take the time to understand the products before adding them into a diversified portfolio, especially as usage is on the rise. About 60% of advisors allocate between 6% and 20% of assets into these products, pointing to factors like diversification, low correlation, enhanced risk-adjusted profile, absolute returns, poor bond market outlook, investments that clients wouldn’t find themselves and enhanced yield, according to Morningstar.
“A lot of advisors are looking to use alternative investments, but … what’s missing from the picture is the clients’ level of understanding of what they own and what that investment is trying to achieve,” Barry Glassman, CFP and president of Glassman Wealth Services, said in the article.
Most investors may hold on to the misconception that these types of hedge-fund-esque investments are some sort of robust money makers. In reality, these strategies are doing exactly what they were made for, diminishing volatility.
“By looking at these funds just as a piece of the entire portfolio, it may help the portfolios generate lower volatility during turbulent times and, in turn, allow the investor to fight off the behavioral urge to sell at market bottoms,” Adam J. Reinert, CFP with the Marshall Financial Group, said in the article.
These types of alternative ETF strategies diversify a portfolio since their returns are not closely correlated to stocks or bonds. During a bullish market condition, though, alternative strategies can underperform. However, when markets are volatile, alternative investments could shine.[Investors May Be Overlooking Alternative Investments, ETFs]
For more information on the ETF industry, visit our current affairs category.
Max Chen contributed to this article.