EC Mid-Year Appraisal Of Alternative ETFs

Alternative investment (“alts”) shone over the past four weeks, at least relative to the broad equity market. Only one of our 14 benchmark ETFs fared worse than the SPDR S&P 500 Trust (NYSE Arca: SPY) in June. The blue-chip stock proxy gave up nearly 1 percent of its market value between May 29 and June 26.

Ten alt ETFs earned positive returns, led by:

  • the SPDR Bloomberg Barclays Convertible Securities ETF (NYSE Arca: CWB), a portfolio of convertible bonds and preferred stocks;
  • the SPDR Gold Shares Trust (NYSE Arca: GLD), backed by London-vaulted bullion, and
  • the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (Nasdaq: PDBC), nominally an actively managed basket of futures optimized to curtail negative roll yields.

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Two table-toppers—CWB and GLD—are in the black for the year, which is more than can be said for SPY. Gold’s clearly the standout exposure, measured by its gross return and by dint of its diversification power.

Diversification is the raison d’être for alts. An ETF’s effect on a portfolio can be measured by its diversification ratio, a factor describing the reduction in overall volatility achieved by the ETF’s addition.

Over the past three years, a classically balanced portfolio—60 percent stocks and 40 percent bonds—earned a diversification ratio of 1.15 versus stocks alone. Further diversification can be attained, differentially, by adding any of the alts ETFs in the table. The degree of additional diversification is reflected in the rightmost column.

For example, the diversification ratio for a 50%/40%/10% mix of stocks, bonds, and gold is 1.26, 11 points higher than that of the classic 60%/40% portfolio.

GLD also enjoyed a strongly positive inflow in June. GLD’s market price is driven by the value of its underlying bullion, not by secondary market trading volume, so fund flow is a telling indicator of investor interest.

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Disclosure: None.

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