With the appeal of alternative investment strategies growing among financial advisers, many of the more sophisticated alternative strategy exchange-traded funds are coming of age at just the right time.
Although most advisers and planners consider the use of alternatives ETFs a fringe part of their practices, new product lines and managers who specialize in the more exotic and creative strategies are contributing to growth in their utilization.
Morningstar Inc. ETF managed-portfolio strategist Andrew Gogerty tracks a bustling subcategory of separate-account managers specializing in the use of alternatives ETFs.
“We're definitely seeing the growth of launches of separate-account strategies that are focused on alternatives, and I think this is going to be the next wave of popular strategies,” he said. “As the [alternatives ETF] space continues to grow and deepen, there will only be more ways to use them.”
As part of his research, Mr. Gogerty has identified 500 of the largest managers of ETF separate-account portfolios.
Assets in the ETF portfolios overseen by those managers have grown by 34% over the past year to more than $45 billion.
The majority of the ETF separate accounts are being constructed and managed for advisers on behalf of their clients.
INCREASED INTEREST
“The last couple of years, we've seen increasing investor interest in more-sophisticated strategies because the market has been very choppy and driven by macroeconomic factors, and less so on fundamental factors,” said Todd Rosenbluth, an ETF analyst at S&P Capital IQ.
“If you want to play the market's volatility, some of these volatility-based ETFs can give you a chance to do that — or even a chance to reduce your exposure to volatility,” he said. “From a currency standpoint, we've seen dollar strength versus the euro and other assets, so you can also use ETFs to hedge and try to benefit from that trend.”
Precious-metals ETFs represent the largest subcategory of alternatives ETF strategies, with the $67 billion SPDR Gold Shares ETF (GLD) accounting for almost half the $140 billion in alternatives ETF assets.
If commodities-based strategies are excluded from the alternatives ETF category, the assets in the two largest funds combined add up to less than $3 billion, and only two of the next eight largest funds have more than $500 million.
The strategies employed by the 10 largest alternatives products not related to commodities are as eclectic as it gets.
The $1.6 billion iPath S&P 500 VIX Futures ETN (VXX) is designed to track the daily volatility of the S&P 500.
The $1.2 billion PowerShares DB U.S. Dollar Index Bullish (UUP) is designed to replicate the performance of being long the U.S. dollar against the euro, yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
CURRENCY PLAYS
Rounding out the the top 10 are ways to play the Australian dollar, Canadian dollar, Swiss franc and Chinese yuan individually, as well as leveraged volatility, hedged volatility, emerging-markets currencies and inverse exposure to equities markets.
While patterns are easily identifiable in the mutual fund arena, the activity in the alternatives ETF space paints a less clear picture because many of the products are designed not so much to be portfolio allocations as they are tools for managing risk and enhancing performance.
Many of the leveraged and inverse products, for example, are actually designed as trading vehicles because the price resets daily, meaning that over longer periods, the leverage or inverse effects can be amplified or muted, depending on market volatility.
The complexity seen in many of the alternatives ETF strategies might make it more difficult for advisers to allocate to individual products, but it also helps lay the foundation for that new breed of specialists identified by Morningstar.
“Part of the reason we're seeing a lot of these [alternatives ETF] strategies used in separate accounts is that, unlike launching a mutual fund, a separate account has a low barrier to entry,” Mr. Gogerty said.
That very well might be the case, but the market also has been moving beyond separate accounts, with a growing list of mutual funds exclusively investing in alternatives ETFs.
Innealta Capital, which manages $3 billion in various separate accounts using ETFs, this year launched two rotation mutual funds using ETFs
“A lot of advisers don't want to use leveraged ETFs, because anything with the word "leverage' in it still scares some people,” Innealta partner Scott Silverman said.
The two mutual funds are the $16 million Innealta Capital Country Rotation Fund (ICCIX) and the $39 million Innealta Capital Sector Rotation Fund (ICSIX).
“We use the leveraged ETFs so we can use less collateral, and that means we can use the freed-up collateral for other income-producing areas,” Mr. Silverman said.
Christian Wagner, chief executive and chief investment officer at Longview Capital Management, also expanded his alternatives ETF separate-account strategy to launch a mutual fund in the past year.
The $34 million Longview Global Allocation Fund (LONGX) uses alternatives ETFs to capitalize on relative strength across multiple asset classes.
“Our use of ETFs allows us to be tactical in the application of risk in the portfolio,” Mr. Wagner said.
In some respects, the development and increasing sophistication of alternatives ETFs are leading the products past financial intermediaries and laying the foundation for their use in separate accounts and mutual funds.
Much of the growth in the alternatives ETF area is due to the increased use by managers of separate accounts and mutual funds, said Nadia Papagiannis, director of alternative fund research at Morningstar.
The turning point at which advisers will start using the more-complex alternatives ETF strategies in client portfolios will be when the alternatives start to look and feel more like mutual funds, she said.
“Alternative ETFs have a long way to go before they have funds equivalent to some mutual fund strategies,” Ms. Papagiannis said. “It will be a while before we get a good market-neutral or managed-futures ETF, so for those strategies where it is more difficult, the advisers will be using mutual funds that invest in alternative ETFs.”
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