Spice Up Your Portfolio With Quantitative ETFs

By Arthur Pinkasovitch | April 07, 2010 AAA

Exchange traded funds (ETFs) are allowing investors to experiment with strategies that were once exclusive to professional portfolio and hedge fund managers. However, rather than paying the typical two and twenty fee structure associated with many hedge funds, regular investors can implement similar strategies at a much lower cost. While active management certainly carries numerous advantages, often justifying the high fees, those who cannot meet the minimum capital requirements should consider the following alternatives.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Mergers and Acquisitions
The IQ ARB Merger Arbitrage ETF (NYSE:MNA) mimics the ARB Merger Arbitrage Index. Merger arbitrage involves purchasing the shares of the target company while simultaneously shorting those of the acquirer in a merger deal. If the deal goes through, shareholders of the target will receive a premium, usually around 20-35%, while the acquirer will experience dilution and a subsequent share price decrease. MNA mimics the ARB Merger Arbitrage Index which takes a long position in target companies after a major announcement has been made, and shorts the general index rather than the acquirer.

This week, for example, the fund has purchased over 52,000 shares of Arrow Energy which is in negotiations with Shell (NYSE:RDS.A) and is selling shares of Smith International (NYSE:SII) - its largest equity holding at 14.16% - which has recently been acquired by Schlumberger Limited (NYSE:SLB). Although not a typical merger arbitrage fund, MNA carries an expense ratio of only 0.75% and sets a precedent for future quantitative ETFs.

Technical Analysis
The PowerShares DWA Technical Leaders ETF (NYSE: PDP) tracks the performance of the Dorsey Wright Technical Leaders Index, investing in 100 securities, including options, which show powerful relative strength indicators. Rather than performing personal technical analysis, PDP reflects the research of experienced investment professionals. A 0.69% gross expense ratio allows investors to participate in the ETF, saving on the costs of investing in a pure technical fund.

The top holdings of this instrument include American Tower Corp (NYSE:AMT) and Apple (Nasdaq:AAPL), which continue to sore to new highs and definitely provide momentum for the ETF. The major advantage of PDP is that Dorsey Wright analyzes 3,000 companies, saving investors the agony of filtering through thousands of stock charts.

Dynamic ETFs
The Intellidex Methodology assesses corporate sectors and equities based on fundamentals, valuation, timeliness and risk. Filters and investment rankings, among other factors, are implemented to create optimal intellidexes based on desired market exposure, market cap and style criteria. The Powershares Dynamic Market Portfolio ETF (NYSE:PWC) tracks the Dynamic Market Intellidex Index which is created using the aforementioned strategy. Forbes classified such investment tools as "ETFs with Brains".

Similar to the other actively managed ETFs, PWC carries an expense ratio of 0.60%. These actively managed ETFs are more expensive to hold than some of the traditional broad market and index oriented instruments due to the high level of involvement required by management. Nonetheless, they are still cheaper than investing directly with an investment fund.

Bottom Line
Actively managed ETFs, especially MNA, are subject to a high level of scrutiny and criticism and do not yet compose a large portion of the available funds that are available to investors. The volume on these tools does not yet compare to that associated with larger, more common products such as the MSCI Emerging Markets Index ETF (NYSE:EEM). However, MNA, PDP and PWC reveal the creative additions that investors can make to their portfolios at a relatively cheap price. (To take full advantage of these vehicles, you need to know how they can fulfill certain strategies. To learn more, see How To Use ETFs In Your Portfolio.)

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