As traditional investments hover near record heights, investors may look to liquid alternative investments and related exchange traded funds to diminish portfolio risks.
In the Seizing Alternative ETF Opportunities panel on the annual online ETF Trends Virtual Summit (available on-demand for up to 4 CE Credits), Salvatore Bruno, Chief Investment Officer and Managing Director of IndexIQ, pointed to four main alternative investments that investors have traditional utilized to diversify away from stocks and bonds, including real estate, commodities, hedge fund strategies and private equity.
Breaking down broad groups, especially among the various hedge fund strategies, Bruno specified some particular alternative investment strategies that have grown in popularity since the financial downturn, such as long/short equity that take both long and short stock positions, unconstrained bond that invest tactically across individual fixed income sectors, global macro that try to capitalize on various global economic variables that affect investments, merger arbitrage that focus on opportunities from corporate transactions, multi-strategy that allocates among various alternative strategies in response to market opportunities and market neutral that matches short against long positions to neutralize risk.
Bruno sees investors are increasingly seeking diversification tools like alternative assets as intertwined global financial markets result in greater correlation across assets.
“The lower correlations to traditional stock and fixed-income investments may result in enhanced diversification,” Bruno said.
For example, the IQ Hedge Multi-Strategy ETF (NYSEArca: QAI) provides a diversified mix of alternative strategies, including multiple hedge fund investment styles, such as long/short equity, global macro, market neutral, event-driven, fixed income arbitrage and emerging markets.
Investors focus on specific strategies through targeted alternative ETFs. For instance, the Index IQ Merger Arbitrage ETF (NYSEArca: MNA) provides investors with a diversified approach to a group of takeover targets. The ETF employ a type of alternative, “directional hedge fund strategy” called merger arbitrage. Specifically, the funds capture the spread or difference between a stock’s trading price before a deal is announced and its eventual takeover price.
Additionally, the IQ Leaders GTAA Tracker ETF (NYSEArca: QGTA) follows tactical asset allocation or event driven strategy that adapts to changes in the market environment. The IQ Hedge Event-Driven Tracker ETF (NYSEArca: QED) is also designed to mirror hedge funds’ event-driven strategies.
The IQ Hedge Long/Short Tracker ETF (NYSEArca: QLS) is designed to mirror hedge funds’ long/short strategies.
The IQ Hedge Market Neutral Tracker ETF (NYSEArca: QMN) tries to give consistent returns in any market with low volatility. The ETF is the first to use a market neutral strategy by copying market neutral hedge funds.
The IQ Hedge Macro Tracker ETF (NYSEArca: MCRO) tries to replicate the risk-adjusted return characteristics of a macro strategy.
During periods of market selling in traditional assets, these types of liquid alts can experience lower drawdowns or even positive returns, which may help buoy an investment portfolio during troubled times.
George Milling–Stanley, Head of Gold Investment Strategy at State Street Global Advisors, argued that gold has historically had lower correlation relative to major asset classes in the long-run, including a relatively flat correlation to the S&P 500 and slightly positive correlation to the Barclays U.S. Aggregate Bond Index over the past decade.
Moreover, Milling-Stanley pointed out gold offers other benefits, such as providing a hedge against currency depreciation and protection against inflation.
Investors can gain exposure to gold through physically backed commodity ETFs, like the SPDR Gold Shares (NYSEArca: GLD) and more recently launched SPDR Long Dollar Gold Trust (NYSEArca: GLDW), which tries to hedge currency risks associated with a strengthening U.S. dollar.
Traders can also turn to leveraged and inverse ETFs to hedge market risks.
Leveraged and inverse ETFs “magnify the returns of their benchmark on a daily basis,” Sylvia Jablonski, Capital Markets-Institutional Strategist and Managing Director at Direxion, said. They “allow investors to gain exposure without the need for full dollar-for-dollar investment.”
Since the leveraged and inverse ETFs rebalance on a daily basis, traders should be aware of the potential side effects of compounding if the investments are held over a longer period. Specifically, the investments may have a lower cumulative return than their benchmark in a volatile market, or they may outperform in a consistently bullish or bearish condition.
Jablonski argued that investors can look to something like the Direxion Daily Financial Bull 3X Shares (NYSEArca: FAS) and Direxion Daily Regional Banks 3x Bull Shares (NYSEArca: DPST) to capitalize on short-term opportunistic views on further strength in the financial sector, or utilize the Direxion Daily Financial Bear 3X Shares (NYSEArca: FAZ) and Direxion Daily Regional Banks 3x Bear Shares (NYSEArca: WDRW) to express short-term hedge of the opposite if your view is mean reversion.
The Direxion Daily S&P 500 Bull 3X Shares (NYSEArca: SPXL) and the Direxion Daily Small Cap Bull 3X Shares (NYSEArca: TNA) could help traders capture a rally in large- and small-caps we continue to see deregulation, favorable tax policies and potential mergers ahead, Jablonski added.
Additionally, the Direxion Daily 20-Year Treasury Bear 3X (NYSEArca: TMV) can help traders express an inverse view on bonds or hedge duration in a rising interest rate environment.
Financial advisors who are interested in learning more about CFP/CIMA accredited panels on the online conference can watch the 2017 ETF Trends Virtual Summit on demand.