If you were to put a group of rocket scientists, academics, and researchers in a jail cell for 10 years with nothing but historical stock market data and a dry erase board, you’d come up with a fund company like IndexIQ. Its rather exotic funds are unique in the world of plain vanilla-indexing, and the fund company seems to have little interest in chasing what’s hot in ETFs.
The IndexIQ Hedge Multi-Strategy Tracker ETF (QAI) is just another one of the company’s unique products.
The Strategies Behind the ETF
The IndexIQ Hedge Multi-Strategy Tracker ETF uses a variety of strategies most commonly employed in quantitative hedge funds. These strategies include:
- Macro trading – Trades based on macroeconomic developments and major market analysis. Such trades are usually directional, long or short.
- Long/short – A long-short fund goes both long and short individual securities, often using leverage to boost returns.
- Market neutral portfolios – Portfolios that seek to generate positive returns from a market-neutral position. A long/short portfolio profits on valuation mismatches in the public markets, while reducing exposure to the broad markets.
- Event driven transactions – Best described as a special situation strategy, event-driven portfolios are based on single events including takeovers, leverage loans, and capital structure arbitrage.
- Fixed-income arbitrage – A strategy that looks for divergence between the price and intrinsic value of fixed-income products. A common fixed-income trade arbitrage trade might be found in US Treasuries and mortgage-backed securities backed by government agencies. Realistically, US Treasuries and MBS should share similar risk profiles, since they are both backed by the same government.
- Emerging markets – Less liquid emerging markets offer better total returns and speculative exposure for IndexIQ’s line up of funds. Emerging markets are especially hot for investors looking to find global growth given that developed nations face their own unique fiscal and economic challenges.
The IndexIQ Hedge Multi-Strategy Tracker ETF is invested proportionally in each of the above six strategies outlined by the company. Essentially, investors have access to a broad range of hedge fund strategies that, when combined, reduce correlation with the broad market while providing more consistent total returns. There are a few asset classes with low correlation that were excluded like Precious Metal ETFs and Timber for instance, but they seem to have come up with a decent formula.
IndexIQ Hedging Returns
As of the 3-year period ended April 30, 2012, the IndexIQ fund returned 4.59% to investors. This return is more impressive when you consider the fund’s beta of .25, meaning it has very little correlation to the S&P500 index with very low volatility. The fund’s beta is slightly higher than most fixed-income funds, but far lower than long-only equities ETFs.
The fund makes a single dividend payment to investors each year. Since inception in 2009, investors were rewarded with annual dividend yields of .85%, 1.52%, and 1.36%. The fund carries a hefty balance of the fund in short-term fixed income products. As of May 25, 2012, the largest three ETFs within this ETFs portfolio were bond funds, which made up nearly 32% of all assets under management.
The construction of the portfolio is subject to change. As new strategies are employed, IndexIQ uses replication to match hedge fund strategies with popular exchange-traded funds. Inside the IndexIQ Hedge Multi-Strategy Tracker fund you’ll find 25 ETFs from issuers like iShares, Vanguard, and State Street Global Advisors.
The fund does come with rather significant annual fees. IndexIQ charges a hefty annual fee of 1.06% for its active management. Given the returns and low correlation, however, investors may be getting their money’s worth. The fund had an asset turnover ratio of 1.45 in 2011, indicating that it made a significant number of trading decisions during the period.
Are Hedge Fund ETFs Right for You?
IndexIQ’s Multi-Strategy fund has limited history, having been introduced in 2009 at a time in which markets had already found a bottom. Going forward, it will be interesting to see how IndexIQ’s unique mix of strategy weathers downturns such as those seen in the US markets in 2008-2009.
Looking through the history, IndexIQ does seem to do quite well for an international stock and bond fund. A unique mix of strategies gives investors very impressive returns insofar as returns are adjusted for correlation. Investors should not expect high total returns, however, as the fund remains primarily invested in short-term debt securities.
IndexIQ is one step ahead of the game, though. The fund company actively-manages its own portfolio with somewhat rules-based methodology. This is a big leap over new ETF filings from issuers like Global X, which seek to build portfolios based on public data surrounding hedge fund managers’ positions documented in 13F filings. IndexIQ is, and likely will be for some time, the biggest player in real hedge fund strategy deployment in the ETF space. Since most of us can’t invest in a hedge fund (here’s why), hedge strategy replicators fill a valuable niche.
Disclosure: the author has no positions in any of the above ETFs.