Warning: Hedge Fund ETFs Have A Few Surprises

by on February 19, 2013 | ETFs Mentioned:

The proliferation of exchange-traded products has essentially democratized the investment  landscape, opening up previously hard-to-reach corners of the market to average investors. While passive, index-tracking ETFs still remain most investors’ top picks, funds with unique methodologies have become more and more popular as investors search for uncorrelated returns. Hedge-fund-like strategies, which once were reserved for only the wealthy, are now available to investors through a single equity ticker [see Cheapskate Hedge Fund ETFdb Portfolio]. 

And while the lineup of funds employing hedge-fund-like strategies is rather small, these products have gotten significant attention from investors looking to get their feet wet in the alternatives pool. A look under the hood of these funds, however, reveals some factors investors should keep a close eye on.

Are Hedge Fund ETFs Worth the Risk and Fees?Hedge Fund ETFs

Whether these ETFs use long/short strategies, merger arbitrage or event-driven trading, what investors most often focus on is bottom line returns. This approach is certainly understandable, as the ultimate goal of these hedge-fund ETFs is to deliver uncorrelated returns to the market or, more specifically, to consistently generate a positive return no matter what the market and economic environments. Though performance metrics are essential, it is also important to factor in the risk and expenses involved with these alternative strategies [see Battle Of The Hedge Fund Clones: GURU Vs. ALFA].

The chart below highlights five of the most popular hedge-fund-like ETF, revealing the differences between volatility, performance and expense ratios:

  • IQ Hedge Multi-Strategy Tracker ETF  (QAI)
  • IQ Hedge Macro Tracker ETF (MCRO)
  • Hedge Replication ETF (HDG)
  • Managed Futures Strategy Fund (WDTI)
  • Merger Arbitrage Liquid Index Fund (CSMA)

Though it is not at all surprising to see hedge-fund-like ETFs charge relatively high fees (though certainly not as high as those charged by actual hedge fund managers), it is important to note that all five of these funds exhibit 200-day volatility figures below 5%; SPY‘s volatility metric comes in at a surprising 11.5%. In regards to performance, however, some of these funds have failed to deliver, clocking in negative returns over the trailing one-year period. HDG and QAI have both fared relatively well, though HDG is slightly more volatile than its competitor. As such, those looking to dive into the hedge fund space should take a close look at all of the options for an appropriate fit.

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Disclosure: No positions at time of writing.