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McCall’s Call: Sleeping Better With QAI

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The S'P 500 Index is down 10 percent for the year, making it tough for investors to swallow. What’s even harder to stomach is the gut-wrenching volatility along the way to those disappointing losses.

Matthew D. McCall

For those interested in hedge-fund replication strategies, a
number of ETFs are on the market to help calm investors’ nerves
and lower daily price swings. So, I want to focus on those,
including those that soften the blow of volatility by going both
long and short.

The average investor portfolio is typically long-only, and when not long, most portfolios will hold cash. Hedge funds on the other hand will almost always utilize their cash and often times use leverage in the direction they feel the market is moving.

For those interested in hedge-fund replication strategies, a number of ETFs are on the market to help calm investors’ nerves and lower daily price swings. So, I want to focus on those, including those that soften the blow of volatility by going both long and short.

Three particular ETFs come to mind that have different hedge-fundlike strategies, so let’s take a look at them.

Index IQ ETFs

The IQ Hedge Multi-Strategy Tracker ETF (NYSEArca:QAI) is designed to track an array of hedge-fund strategies that include long/short, global macro, market-neutral, event-driven, fixed-income arbitrage, and emerging markets.

By attempting to achieve this risk-adjusted return, QAI invests both long and short in various ETFs and other investment vehicles.

As of Sept. 9, the ETF was most heavily weighted in three bond ETFs:iShares iBoxx Investment Grade Corporate Bond ETF (NYSEArca:LQD), iShares Barclays Aggregate Bond ETF (NYSEArca:AGG) and Vanguard Total Market Bond ETF (NYSEArca:BND). The top three holdings make up 47 percent of the entire allocation of QAI. The ETF is down 1 percent for the year and charges an annual fee of 1.13 percent.

In the same family of funds is the IQ Hedge Macro Tracker ETF (NYSEArca:MCRO). It attempts to replicate a risk-adjusted hedge fund macro strategy and emerging markets strategy.

MCRO’s big three holdings are LQD, Vanguard MSCI Emerging Markets ETF (NYSEArca:VWO) and the iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM). It also has exposure to precious metals and foreign bond ETFs. For the year, the ETF is down 4 percent, not including annual fees of 1.10 percent.

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ProShares

The newly introduced ProShares Hedge Replication ETF (NYSEArca:HDG) seeks to track the performance of the Merrill Lynch Factor Model. The goal is to achieve returns similar to that of the broad hedge fund industry.

The ETF attempts to meet its goal by using six factors with varying weightings— both long and short. Those factors include the S'P 500 Total Return Index, the Russell 2000 Index, the MSCI Emerging Market Index, the MSCI EAFE Index, the ProShares UltraShort Euro ETF (NYSEArca:EUO) and the three-month U.S. Treasury bill.

The new ProShares hedge fund ETF began trading on Aug. 18, and hasn’t really caught on yet. In fact, it has had several days with zero trading volume.

It has a 0.95 percent expense ratio and it’s reallocated monthly. Currently, the ETF has 73 percent of its assets in U.S. zero-coupon bonds (maturing in December 2011).

It appears this strategy hasn’t been embraced by investors and, based on the way it attempts to replicate hedge fund performance, I don’t see it ever making a big splash.

I feel this way because even though the ETF attempts to use an alternative/hedging strategy, the fund is handcuffed with the choice of only using six factors. A better approach would allow for more options when it comes to hedging.

Which And When

Of the three hedge-fundlike ETFs I laid out, I prefer QAI, because it implements a number of hedge fund strategies that can help lower the volatility and therefore can be a true hedging vehicle.

The ETF is easily beating the S'P 500 and most indexes around the globe. In 2010, QAI was up 1 percent, and the S'P 500 was up 13 percent. The numbers can be skewed because the amount of risk with QAI is dramatically lower than that of the S'P 500.

Going back to the index inception on Sept. 25, 2008, the IQ Hedge MS Index is up 2.93 percent annually, versus a gain of 6.06 percent for the S'P 500. Again, the numbers tell a one-dimensional story, but with risk inserted into the equation, QAI becomes much more attractive.

Investors should utilize QAI for what it is—a hedging vehicle. The gains will never be large, nor will the losses.

In other words, during a raging bull market, you want to stay clear of QAI. But with the current volatility, this ETF could help you sleep at night.

Matthew D. McCall is editor of The ETF Bulletin andpresident of Penn Financial Group LLC, a New York-based wealth management firm specializing in investment strategies using ETFs.

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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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