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 (
) . Picture that, and then you'll see what the
IQ Hedge Macro Tracker ETF
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
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
For example, the largest holding is
iShares MSCI Emerging Markets (
, which in turn owns
Petroleo Brasileiro (
Taiwan Semiconductor (
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
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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.
Editor: Market Advisor, The ETF Authority
Disclosure: Nathan Slaughter does not own shares of any security
mentioned in this article.
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