What if you could index the investment strategies of hedge fund managers? And what if you could do it with lower fees, better tax efficiency and greater transparency? One company that believes it has found a way to accomplish this feat is IndexIQ.
The New York City-based asset manager was founded in 2006 on the premise that indexing can be successfully applied to high quality institutional investment strategies.
IndexIQ has developed its own lineup of hedge fund indices that incorporate long/short, market neutral, fixed income arbitrage, event driven and global macro strategies. The company believes that financial advisors can help their clients to reduce risk and increase returns by adding these types of strategy ETFs to the overall asset mix.
At the end of May, IndexIQ managed around $488 million in spread across nine ETFs.
Research magazine interviewed Adam Patti, CEO of IndexIQ about the state of the ETF investing.
How has indexing evolved from its origins to where it’s at today?
Actively managed “alpha” is very difficult to find and even more inconsistent, largely due to the sheer number of active managers in the market who compete away the finite number of market inefficiencies which are the basis of “alpha.” It was a natural evolution for indexing to move beyond the traditional passive indexes, which were designed as benchmarks, not necessarily as optimal investment strategies, to more sophisticated methodologies that were specifically designed to provide investors access to more unique exposures and more sophisticated investment strategies.
Today, index investors can access many investment strategies that were once the exclusive domain of active managers. These indexes have proven that in fact much of the value driven by active managers has actually been in their investment process which can be boiled down to a rules-based methodology. The difference of course is that when packaged as an index, the products can have lower fees, full transparency and, if designed properly, greater consistency in terms of pattern of performance.
Commodities have gotten clobbered this year, but higher inflation due to currency debasement is always a threat. What are some ways to guard against this?
Investors need to be careful how they express their commodity exposure. For one, what kind of exposure are you looking for? Some of the “diversified” commodity ETFs on the market are little more than energy funds masquerading as diversified commodity funds.
Another thing to look at is whether you want your commodity exposure coming through derivatives or through equities. Both have their pluses and minuses. However, most investors don’t understand how the pattern of performance of derivative based strategies are impacted by contango and backwardation. Nor do they typically expect the K1s that are often tied to the derivative-based strategies. Also, investors need to understand that equity-based commodity strategies typically don’t provide the diversification benefits they are looking for given that commodity producer equities typically have higher correlation to the equity markets then the derivative-based products.
IndexIQ launched the IQ Global Resources ETF (GRES) in 2009 as the broadest natural resources ETF in the marketplace. It includes all of the major commodity sectors that the competing products include; however it also includes timber, water and coal as standalone sector exposures.
GRES is never overly concentrated in any one of its eight commodity sectors because GRES rotates among those sectors monthly using momentum and valuation factors to “buy low and sell high,” while capping any sector’s exposure to 22.5% of the portfolio. And while GRES is an equity-based strategy, it includes 20% short exposure to the global equity markets to pull out that equity beta and reduce volatility. The result is a product that offers the diversification benefits of a derivative-based commodity fund with among the highest returns and lowest volatility in its competitive set in each year since inception. This year alone we are ahead of the Dow Jones UBS Commodity Index benchmark by 4-5%.
The IQ Hedge Multi-Strategy Tracker ETF (QAI) and the IQ Hedge Macro Tracker (MCRO) just celebrated their 3-yearanniversaries and these particular ETFs were a breakthrough offering on many fronts. Tell us more.
Hedge funds have been a core alternative holding for institutional investors for 25 years. They diversify a portfolio by providing low volatility, low correlation downside protection in rough markets, yet retaining upside potential when the markets turn positive. Most investors haven’t had access to this important exposure, so we at IndexIQ focused on providing it in a low cost, transparent, tax efficient wrapper.
QAI and MCRO provide the same pattern of performance as institutionally owned fund of hedge funds, however, with all of the benefits of an index-based ETF structure. Think of QAI as the S&P 500 of the hedge fund marketplace.