In 1993, when the S&P 500 SPDR (NYSE: SPY) appeared as the first exchange-traded fund (ETF), a revolution was born. Today more than $10 trillion, or about 8% of the total mutual fund market, lies within ETFs and similar products. Their tax efficiency, low operating costs and transparency of ownership make ETFs one of the best investment vehicles out there for both institutional and retail investors. However, some more experienced investors have shunned the bland indexing approach in which ETFs thrive, craving more sophistication. While I still believe that exchange-traded products work best following broad sector indexes, there are now ways to get hedge fund-like strategies into one's portfolio. (For a simple ETF portfolio review, see ETFs For A Low-Cost, Long-Term Portfolio.)

IN PICTURES: 20 Tools For Building Up Your Portfolio

Finding Mini-Hedge Funds
At its core, quantitative analysis uses techniques that seek to understand behavior by using complex mathematical and statistical modeling, measurement and research. Investors use these systems for measuring or predicting current or future performance. In addition, quantitative analysis can be used to predict real-world events such as changes in a share price. While technically, quantitative analysis includes simple financial ratios such as earnings per share and yield to maturity - things all investors should be looking at anyway - pursuing a quant strategy for a portfolio should focus on more "intense" tactics. Luckily, plenty of ETFs deal with more professional methods such as technical charting and shorting. (For more, see Quantitative Analysis Of Hedge Funds.)

Bring On The Quants
With the recent launch of the iShares Diversified Alternatives Trust (NYSE:ALT), regular retail investors now have the opportunity to add a hedge fund to their portfolios. The fund hopes to profit from the mispricing of financial instruments by capturing spreads between assets that deviate from the fair value. To accomplish this, ALT will seek to take advantage of interest rate and futures contract price differentials by simultaneously entering into long and short positions in various bond, commodity, equity, currency and interest rate futures. In addition, the fund will buy relatively inexpensive sectors while selling (shorting) expensive ones. The ETF will be actively managed, and iShares charges a hefty, by iShares standards, 0.95% in expenses. However, if ALT is able to achieve its goals, it may be perfect as a poor man's hedge fund.
Plenty of commodity-based ETFs on the market now have one unparticular adding a quantitative spin. The Elements S&P Commodity Trends Indicator­ Total Return ETF (NYSE:LSC) owns sectors that have been moving up, assuming prices will keep rising, and bets against commodities with falling prices. The exchange-traded note follows energy, industrial metals, precious metals, livestock, grains and softs and has been fairly successful. While the broad commodity iPath Dow Jones-AIG Commodity ETF (NYSE:DJP) fell 39% during last year's commodity bust, LSC held its own. The note is set to expire in 2023 and charges 0.75% in expenses.

Technical charting specialists Dorsey, Wright and Associates have refined their techniques to analyze more than 3,000 different stocks based on momentum and relative strength. Applying these skills to emerging-market stocks to find the best rockets makes perfect sense. The PowerShares DWA Emerging Markets Technical Leaders (NYSE:PIE) follows 100 companies that possess powerful relative-strength characteristics and are domiciled in emerging-market countries. While the fund has failed to outperform the broad index, it could be due to the nature of these high-growth stocks falling harder during the recent crisis. The fund does have many positives including heavy weightings to Indonesia and Malaysia as well as a 35% weighting toward energy and natural resources. These countries and sector weightings are some of the higher growth areas going forward. The fund charges 0.90% in expenses. (For more information about hedge fund investing, refer to Hedge Funds Hunt For Upside, Regardless Of The Market.)

The Bottom Line
ETFs can form the basis for a great portfolio. Recently, the industry has moved from one of simple indexing into the exotic world of quantitative modeling. As investors move up the sophistication ladder, it may make sense for them to include a small portion of their portfolios toward these funds. The preceding three ETFs allow investors to add hedge fund-like strategies to customize a portfolio.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Filed Under: , , ,
Tickers in this Article: PIE, ALT, LSC, SPY, DJP

comments powered by Disqus

Trading Center