A Hedge Fund for the Rest of Us

By
A A A
Share |

During my former days as a financial advisor, I'd occasionally get a call or email from someone in our "Alternative Investments" department trying to drum up business. Invariably, they wanted me to deposit my clients' assets into a specialized hedge fund utilizing one esoteric strategy or another. Quite often the objectives (and returns) being pitched would pique my interest.

But hedge funds aren't your everyday garden-variety product. Membership in these private investment partnerships is typically reserved for "accredited investors" -- those with annual incomes exceeding $200,000 and/or net worth of more than $1 million.

Unfortunately, that eliminated the majority of my client base, and most of the general investing public for that matter.

That's why the good folks at Index IQ have pioneered a way to "democratize" hedge funds and open the club to everyday investors like you and me.

Mystique aside, hedge fund managers don't have secret, can't-miss trading systems -- they are fallible like everyone else. From time to time, an overleveraged fund blows up in spectacular fashion and rattles the market for a few days, but many manage to generate superior risk-adjusted returns and capture the alpha that eludes most traditional portfolio managers.

Wealthy investors have taken notice.

The number of hedge funds has swelled from 600 to 9,000 during the past two decades. Meanwhile, industry assets have surged more than 30-fold to $1.4 trillion. That accounts for almost one-third of the market's daily trading volume. The pros in charge of pensions, college endowments and portfolios of the rich and famous now allocate as much as 25% to alternative investments, up from just 3% a few years ago.

Of course, there are myriad different hedge -fund strategies. Some attempt to deliver positive absolute returns regardless of whether stocks are moving up or down. Others might profit from spinoffs or chase down arbitrage opportunities in the convertible bond market.

In any case, the goal is to seek out and exploit inefficient prices. To make the most of these opportunities, hedge fund managers aren't handcuffed by the same restraints as mutual fund managers. They can use leverage or short sales, pile into cash, overweight certain stocks or sectors, use derivatives, foreign currencies and other instruments as they see fit.

Unfortunately, these funds can be illiquid and cause headaches at tax time. And management fees are outlandish -- highly skilled managers usually take 2% to start and then skim off as much as 20% of any profits each year.

But think of the benefits of combining hedge fund strategies with the low costs, portfolio transparency and tax efficiency of an exchange-traded fund ( ETF ) . Picture that, and then you'll see what the IQ Hedge Macro Tracker ETF (Nasdaq: MCRO) is all about.

Launched a few months ago, this innovative ETF is a synthetic hedge fund. The index it tracks is unlike any other you'll find -- governed by a set of quantitative rules and algorithms set down by a hand-picked team of brainiacs. Chief Investment Strategist Robert Whitelaw has a mathematics degree from MIT and a Ph.D. in finance from Stanford.

As I've said, hedge funds come in several different flavors. This one is macro-driven, meaning geopolitics, commodity prices, inflation , employment, interest rates and other big-picture global factors are carefully evaluated. The conclusions reached will determine where the portfolio goes -- it could be skewed to foreign government bonds one day, real estate the next.

At the moment, the portfolio is short small-cap Russell 2000 futures and long emerging markets stocks, short-term bonds, commodities and foreign currencies. But rather than hold individual securities, exposure to any given asset class is done through other ETFs.

For example, the largest holding is iShares MSCI Emerging Markets ( EEM ) , which in turn owns Petroleo Brasileiro ( PBR ) , Taiwan Semiconductor ( TSM ) and dozens of other emerging market stocks. This fund-of-funds concept adds another layer of diversification and protection.

Because MCRO has only been trading a few months, the jury's still out on whether it can successfully duplicate hedge-fund performance over the long-haul. But back-tested data shows the IQ Hedge Composite annually outrunning its Credit Suisse/Tremont benchmark by more than 300 basis points during the past five years, with less volatility.

Action to Take --> The fund isn't cheap. Index IQ charges 0.75% for its services each year -- in addition to fees for underlying portfolio holdings like EEM. But that's a tiny fraction of what you'd pay for a true hedge fund. And if MCRO's managers can successfully read the macro tea leaves and double-down in just the right spots, it could be well worth the cost.


Nathan Slaughter
Editor: Market Advisor, The ETF Authority

Disclosure: Nathan Slaughter does not own shares of any security mentioned in this article.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Stocks

Referenced Stocks: EEM , ETF , MCRO , PBR , TSM

Nathan Slaughter

Nathan Slaughter

More from Nathan Slaughter:

Related Videos

Stocks

Referenced

Most Active by Volume

89,970,926
  • $16.15 ▲ 0.12%
77,131,582
  • $58.94 ▼ 1.31%
67,336,935
  • $26.56 ▲ 1.68%
48,814,124
  • $86.20 ▲ 0.02%
47,526,126
  • $23.21 ▲ 0.78%
44,660,424
  • $23.91 ▲ 6.36%
38,799,699
  • $4.289 ▲ 4.36%
36,199,890
  • $40.01 ▼ 0.97%
As of 4/17/2014, 04:07 PM