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ETFs

ETFs Go After Hedge Funds

New exchange-traded funds sell short, invest in foreign currencies and engage in other esoteric strategies.

It was only a matter of time. Exchange-traded funds, which offer products for almost every conceivable investment niche, are now competing with hedge funds. This could be welcome news if you don’t have the big bucks normally required to invest in hedge funds and don’t want to pay their outrageous fees.

Hedge-fund ETFs don’t follow a simple formula. IndexIQ, the top sponsor of these kinds of ETFs, aims to replicate the returns of hedge funds by investing in other ETFs and futures contracts. Its IQ Hedge Multi-Strategy Tracker (symbol QAI) uses hedge-fund techniques, such as selling stocks short as well as owning them and seeking to take advantage of discrepancies in the prices of different kinds of bonds from the same issuer. IQ Hedge Macro Tracker (MCRO) tilts more toward emerging-markets stocks and will almost certainly be more volatile than the multi-strategy ETF.

The biggest ETF purveyor, iShares, has also gotten into the act. Its Diversified Alternatives Trust (ALT) holds futures contracts on commodities, currencies and interest rates, as well as on stock and bond indexes. Unlike most ETFs, Diversified Alternatives Trust is actively managed and does not track an index.

Fees for these new ETFs are either fair or high, depending on your perspective. The annual fee for the iShares ETF is 0.95%; the IQ ETFs charge 0.75%, although total costs are closer to 1.1% when you include the fees of the underlying ETFs. That’s better than the standard hedge-fund charge of 2% per year plus 20% of the gains, but a lot higher than most ETFs, some of which charge less than 0.1% annually.

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Hedge-fund-mimicking ETFs are untested. The oldest fund offered by IndexIQ started in March 2009, and iShares launched its product in November. Until we see how these funds perform in different market environments, we suggest you steer clear of them. Instead, consider a seasoned hedge-fund-like mutual fund, such as Hussman Strategic Growth (HSGFX), or a merger-arbitrage fund (see How to Make Money on Mergers).