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Do Ask What These Alternative ETFs Can Do For You

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In today's volatile markets, alternative strategy ETFs have been popping up on investors' radar screens as potential ways to diversify or to take advantage of some of the market swings.

But various types of investors highly under-use the investment segment, according to a recent study by Cerulli Associates. Why is that, and what is the investments' real value-added in a portfolio?

Traditional investments involve simply buying, holding or selling stocks and bonds, either individually or in diversified portfolios, including ETFs and mutual funds. Alternative strategies usually focus on nontraditional investments and may include long/short, leveraged, inverse, managed futures, arbitrage and hedge fund investing.

The largest ETFs available in the market include IQ Hedge Multi-Strategy Tracker ( QAI ), WisdomTree Managed Futures Strategy Fund ( WDTI ), IQ Merger Arbitrage ( MNA ) and First Trust Long/Short Equity ( FTLS ). QAI is the largest with assets of $1.1 billion, followed by WDTI with $200 million, MNA $122 with million and FTLS at $113 million.

Aside from QAI, which has an average trading volume of over 220,000 shares, these ETFs trade an average of 26,000 to 38,000 shares a day, which makes them not as liquid as many traditional investments. Their fees are at or slightly below 1% -- not the cheapest when compared to other asset classes, either.

While institutional investors have shown interest in alternative strategy ETFs, "in the financial advisor community (representing retail investors), there still is a lack of adoption," noted Jennifer Muzerall, associate director at Cerulli Associates. The Cerulli report points out that 2015 allocations to those funds range from 5% for conservative investors to approximately 7% for aggressive investors.

Muzerall cites a lack of education in the advisor community as well as difficulties with indexing alternative ETF products. Those funds experienced nearly $10 billion in outflow in January as investors flocked to the safe haven of taxable bond funds.

"The alternative ETFs universe is a very small fraction of the overall ETF universe," said Muzerall. "There're only 340 alternative ETFs in a landscape of over 1,700 products, and the asset size is very small."

That said, 45 alternative ETFs were introduced in 2015, making it the most robust product development for alternatives since 2007, the Cerulli study says. A major advantage that those ETFs offer investors is "getting access to what's historically been known as harder strategies to get exposure to on the retail side," said Muzerall.

Alternative strategy ETFs offer investors a way to diversify, including adding potential downside protection. Morningstar analyst Josh Charlson says that a typical allocation ranges from 5% to 10% in a portfolio.

Charlson notes that the strategy is usually more suitable for more sophisticated investors. "I don't think it's something you just go into because there is market volatility. I think it's something to have in your portfolio all the time as a strategic allocation."

ETF manager WisdomTree recently launched CBOE S&P 500 PutWrite Strategy ( PUTW ), which tracks the index of the same name. The fund's goal: provide investors with the opportunity to reduce volatility in the S&P 500 index. The fund collects income by writing monthly at-the-money put options on the S&P 500, thereby betting that the index will not be down by the end of the month.

"What we wanted to do is give investors a way to take advantage of this strategy, which is very well known and used in the industry, which is writing puts and collecting put premiums on the S&P 500, and do it inside an ETF," said WisdomTree Chief Investment Strategist Luciano Siracusano.

If the S&P 500 rises by the end of the month, the option expires and the fund keeps the income. The fund is still tiny, at $3.8 million in assets, but carries a relatively cheap fee of 0.38%.

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

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

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