ETF Expert

Remember the day when an exchange-traded fund was as easy to grasp as the sunshine is bright? No longer!

On Monday, 11/16/09, iShares launched the Diversified Alternatives Trust (ALT). Its stated objective? Well… that’s too long for a gifted speaker to say aloud on a single breath of air. (Go ahead… try it for yourself!)

“The objective of the Trust is to maximize absolute returns from its portfolio of exchange-traded futures contracts (that may involve commodities, currencies, interest rates and certain eligible stock or bond indices) and foreign currency forward contracts, while seeking to reduce the risks and volatility inherent in those investments by taking long and short positions in historically correlated assets.”

In truth, laying out this conceptual ETF in plain English is quite a challenge. The Diversified Alternatives Trust (ALT) will attempt to garner ”absolute gains” primarily from foreign currency and commodity futures contracts; at the same time, ALT will take long and short investment positions to help reduce ALT’s overall volatility.

So why might you be interested in the latest alternative investment? ALT is investing in stuff that may not crash if more traditional assets (e.g., stocks, bonds, money markets, etc.) falter. What’s more, it is sophisticated and “hedge-fundy.” Perhaps you feel the need for greater protection than a standard mix of the 3 biggies… stocks, bonds and cash.

However, if you go through the list of reasons why to invest in ETFs at all, the Diversified Alternatives Trust (ALT) won’t pass muster. And here’s why:

1. Expense. One of the reasons that no-load, no-commission mutual funds have beaten the pants of commission-based, load mutual funds is because no-load funds are much cheaper. Similarly, most ETFs outperform actively managed mutual funds — no-load and load — because they passively track established indexes at an average expense of 0.5%; actively managed mutual funds have typically averaged an expense of closer to 1.4% per year.

ETF indexing means low cost. It also means low turnover… which is synonymous with greater tax savings in taxable accounts. Unfortunately, the Diversified Alternatives Trust (ALT) is expected to cost a hefty 0.95% for the privilege of its ticker. Moreover, it won’t be tracking any index… so you won’t be able to count on tax-efficiency saving you any money.

2. Transparency: ETFs are better than traditional mutual funds because you know all of the investments that an ETF holds/tracks. The holdings are the same as the indexes themselves. With mutual funds, you get quarterly updates on what a fund manager may be doing, but for the most part, you’re investing in the track record of the person/team managing the mutual fund.
 
On transparency, the Diversified Alternatives Trust (ALT) is at least going to be able to tell you what you have on a day-by-day basis. However, you’re not going to know whether the fund manager is doing a good job at managing the sophisticated strategies of “curve arbitrage,” “technical momentum/reversal,” and “fundamental relative value.” This is a “buy-it-n-hope-the-manager-is-talented” investment.

3. Trade-ability: ETFs are better than traditional mutual funds because ETFs trade like individual stocks. If you want to hold them for the so-called long-term, you can. If you want to manage downside risk by employing stop-losses, you can do that at any price point you want. You can even set a pre-determined buy price that is attractive.

On trade-ability, you should have the ability to buy or sell the Diversified Alternatives Trust (ALT) throughout the trading day. Yet this inauguration will be met with enough skepticism and low volume, that the bid-ask spread will be wide. A wide bid-ask spread adds yet another layer of expense for cost-conscious investors.

This last area is perhaps the most ironic. Specifically, the reason that iShares has launched ALT is to use the diversification of alternative investments to guard against a simultaneous collapse in stock, bond and commodity indexes. Yet the lesson of the 2008-2009 all-asset collapse was not to master the timeless quest for non-correlating asset classes (i.e. diversification); rather, the biggest take-home was the critical importance of liquidity.

In other words, unlike mutual funds, the best ETFs have suffficient trading volume and they can be converted to cash quickly. With Diversified Alternatives Trust (ALT), it is unlikely that enough shares will be trading if an epic asset liquidation occurs. (Want to sell it if markets are imploding… LOL, lots of luck!)

If you’d like to learn more about ETF investing… then tune into “In the Money With Gary Gordon.” You can listen to the show “LIVE”, via podcast or on your iPod.