investing

Steer Clear of Hedge-Fund ETFs

These relatively new exchange-traded funds don’t have long enough track records for us to recommend them.

It was only a matter of time. Exchange-traded funds, which offer products for almost every conceivable investment niche, are now going after hedge funds. You may consider this 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) attempts to replicate six hedge-fund techniques in one fund. Techniques range from selling stocks short to taking advantage of discrepancies in the prices of different kinds of bonds from the same issuer.

The IQ Hedge Macro Tracker (MCRO) tilts more toward emerging-markets stocks and will almost certainly be more volatile than the multi-strategy ETF. The macro ETF endeavors to create returns similar to two types of hedge-fund investing styles -- global macro and emerging markets.

Global-macro hedge funds search for inefficiencies in the prices of stocks, bonds, commodities and currencies around the globe. Emerging-markets hedge funds try to do the same thing, but exclusively in developing countries.

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. It seeks to profit from the gaps between the market price and the estimated true value of assorted assets. Unlike most ETFs, Diversified Alternative Trust is actively managed and does not track an index.

Fees on 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.

Hedge-fund-mimicking ETFs are untested. The oldest fund offered by IndexIQ started in March 2009, and iShares launched its product in November. Many wonder whether these ETFs can come close to reproducing the performance of hedge funds. Michael Johnston, senior analyst of research firm ETF Database, thinks many investors are waiting on the sidelines to see whether funds live up to the hype. “If they impress, the sky's the limit,” he says.

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).

Expect more hedge-fund-like ETFs to hit the market. IndexIQ has filed applications with the Securities and Exchange Commission to launch more than a dozen ETFs. “We are creating very specific products for very specific needs investors have,” says Adam Patti, IndexIQ’s chief executive.

Most Popular

You'll Save More on Green Home Improvements Under the Inflation Reduction Act
Tax Breaks

You'll Save More on Green Home Improvements Under the Inflation Reduction Act

Tax credits for energy-efficient home improvements will be extended and expanded by the Inflation Reduction Act.
August 12, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
The 25 Cheapest U.S. Cities to Live In
places to live

The 25 Cheapest U.S. Cities to Live In

Take a look at our list of American cities with the lowest costs of living. Is one of the cheapest cities in the U.S. right for you?
August 7, 2022

Recommended

3 Dated Rules of Thumb Retirees Should Think Twice About
investing

3 Dated Rules of Thumb Retirees Should Think Twice About

The tried-and-true investing and saving rules of thumb retirees depend on may no longer be as reliable as they hoped. Don’t let dated “rules” steer yo…
August 11, 2022
The Good News About Recessions for Investors
investing

The Good News About Recessions for Investors

Yes, an official recession is possible, but based on previous recessions, there could be reasons for investors to smile. With that in mind, here are t…
August 11, 2022
Has Inflation Peaked? Here's What the Experts Are Saying
investing

Has Inflation Peaked? Here's What the Experts Are Saying

Inflation decelerated by more than expected in July, but that doesn't mean our era of fast-rising prices – or Fed rate hikes – is over.
August 10, 2022
Inflation Reduction Act a Blessing in Disguise for Drug Stocks?
investing

Inflation Reduction Act a Blessing in Disguise for Drug Stocks?

Coming limits on drug pricing may not be bad news for drug makers after all.
August 10, 2022