What's Inside Your Hedge Fund ETF?

Multi-strategy hedge funds are supposed to be absolute return investments. Can the strategies work in a low-cost exchange traded fund?

When I hear the term “hedge funds,” I can’t help but think of an ice cream parlor. The place that advertises its “31 Flavors.” Why? Because of all the choices available.

Accredited and institutional investors are also faced with a myriad of choices when they consider private placements. Instead of strawberry, lemon custard and orange sherbert, of course, investors have to choose from long/short equity, market-neutral, merger arbitrage and event-driven funds—and more. For those who have trouble deciding, there’s the multi-strategy fund—a sort of “tutti frutti” of investment approaches.

Multi-strategy was, in fact, the hedge fund flavor of choice last year as investors, hungering for performance and diversification, switched out of long-only equity strategies. Multi-strategy hedge funds are supposed to be absolute return investments, capable of cranking out positive returns no matter what the equity markets do. Their hallmark is a low correlation to stocks.

Not everyone can pay the rather stiff cover charge required to step into the hedge fund parlor, though. For those left outside, there’s still a way to get hedge fund returns on the cheap—through exchange traded funds (ETFs). Three ETFs provide multi-strategy hedge fund replication:

The IQ Hedge Multi-Strategy Tracker ETF (NYSE Arca: QAI) portfolio is an amalgam of sub-portfolios, each emulating the returns of a specific hedge fund strategy. Mostly composed of ETFs, these sub-portfolios are built by quantitative analysis, actively managed and, when aggregated, are supposed to replicate the returns of a hedge fund of funds. QAI, launched in 2010, is the granddaddy of multi-strategy hedge ETFs.

At last look, the QAI portfolio included more than 60 ETF positions, both long and short, and an equal number of ETF swaps. Fixed-income ETFs, held long, take up the largest portion of the fund’s portfolio.

Then there’s the PowerShares Multi-Strategy Alternative Portfolio Fund (Nasdaq: LALT). An actively managed portfolio like QAI, this fund holds individual stocks among other non-ETF assets. The stocks held long are deemed undervalued and hedged against market beta with equity index futures. LALT also follows a long/short strategy with currency forwards while maintaining a sizeable long exposure in interest rate futures. LALT debuted in 2015.

The ProShares Hedge Replication ETF (NYSE Arca: HDG) takes a passive approach by tracking an index of long and short positions in individual stocks, equity ETF swaps, currency futures and Treasury securities. HDG premiered in 2012.

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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