We recently had the opportunity to talk with Ethan Powell, Chief Product Strategist at Highland Capital Management, about his firm’s recent expansion into the equity ETF space; more specifically, we take a closer look at the three most recently launched funds, the Event-Driven ETF (DRVN), Global ETF (HHFR), and the Equity Hedge ETF (HHDG).

ETF Database (ETFdb): What was the motivation behind expanding your product suite into the equity space?

Ethan Powell (EP): We are further expanding our successful alternative investment solutions into passively managed alternative beta ETFs. We’ve managed alternative funds for 20 years and are product wrapper agnostic. This launch is less about equities and more about providing the investment community with alternative equity solutions in an uncertain market. These products are not a pure equity play, rather hedged or non-correlated equity exposure. We saw the opportunity and collaborated with HFR, an industry-leading hedge fund index provider.

These solutions are unique in the marketplace, though there are a few that are similar. What we are doing with HFR harnesses the alpha-generating capabilities of hedge funds superior security selection, in addition to tactical asset allocation and market exposure management. The other hedge fund replication ETFs in the marketplace are either factor-based replication or use 13F filings to try to mimic hedge funds’ positioning and performance.

What we’re doing with these three ETFs is bringing something to the market that currently isn’t available.

ETFdb: Please elaborate on your relationship with HFR and how that plays into giving you an edge when you consider there are already more established funds in each of the categories you are entering.

EP: HFR has constructed the HFRL series of indices which is the liquid version of their hedge fund indices. What the index does is samples the separately managed accounts run by hedge fund managers under their roughly $2 billion platform. Approximately 70-80 percent of market value of the HFRX separate accounts is included in HFRL, obviously excluding securities that are not appropriate for the ETF wrapper including derivatives and illiquid securities. These are used to construct HFRL, which is rebalanced on a monthly basis.

However, if the market exposure of the HFRX indices moves by more than 10 percent day over day or more than 15 percent week over week, the HFRL exposure is modified accordingly.

ETFdb: What’s the investment thesis behind each of these new products? Please explain how each one works.

EP: DRVN capitalizes on a discipline in the hedge fund community that takes advantage of pending corporate events or other near-term catalysts for revaluation, either upward or downward.

HHDG is a traditional hedged equity strategy that can both long and short securities.

HHFR is the traditional multi-strategy hedge fund that will incorporate fixed income and shorting as well as long equity positions.

We think these strategies are well-suited for a sideways trending, volatile equity market.

ETFdb: What types of investors have been slow to adopt or are potentially major beneficiaries of embracing Alternative Beta ETFs?

EP: The relatively slow adoption rate in alternative beta ETFs is largely attributable to our unprecedented low interest rate environment fueling a broad based rally in risk assets and long only investment solutions. The S&P 500 is trading at over 200 percent from its 2009 lows. The long-only equity ETFs have been a major beneficiary of that.

We think, going forward, the broad based risk asset rally is over, and investors are going to need access to careful security selection and market exposure management. These funds represent both and are a good equity alternative that should deliver muted volatility and downside protection for ETF investors.

Amid the current run-up on Wall Street, it’s wise for investors to consider how their portfolios will fare over the coming years when long-only equity strategies might start running out of steam. As such, the recently launched equity ETFs from Highland Capital warrant a closer look from anyone looking to diversify away from a traditional long-only investment approach.

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Disclosure: No positions at time of writing.