On a recent conference call, Morgan Creek Capital Management’s Mark Yusko pointed to a forecast from GMO’s Jeremy Grantham that for the next seven years, the S&P 500 is expected to produce negative real returns.
The good news is that GMO also predicted positive real returns for emerging markets and commodities. Sometimes investing in traditional areas expected to provide the highest returns requires stomaching volatility. One way to reduce that volatility is with an alternative approach.
First, let’s remove misconceptions that alternative investments work both in bull and bear markets. While that may be the objective for some strategies, better long-term risk-adjusted returns remain the overall goal. This can be accomplished through a variety of ETFs such as market- or beta-neutral, dollar-neutral or relative-value, long-short and any form of either long or short bias.
Among the most popular alternative ETFs are inverse and leveraged beta products. These funds shouldn’t be characterized as alternative solutions but rather as tools to accomplish an alternative approach. Despite existing negative feedback about the daily reset on leveraged ETFs—both long and short versions—such strategies work exactly as intended, although they should be used with a sophisticated model designed to incorporate the daily reset.
If searching for a do-it-yourself solution, then consider using a single beta inverse ETF as a hedge, but make sure a plan is in place when adjusting exposure, such as using a 50- or 200-day crossover signal that helps guide the hedging position’s size. Other options include actively managed equity short ETFs that can be used similarly to single beta inverse strategies, but with the goal to obtain shorting alpha through the manager’s individual stock selection.