Some of the alt ETFs didn't act very alt in the market selloff.
The goal of alternative, or alt, exchange-traded funds, which track such things as commodities and hedge fund strategies, is to provide returns that don't move broadly in tandem with stock and bond markets. Alternative assets can also include physical real estate and private equity, which are used heavily by institutions. When the value of stocks, and many bonds, tumbled recently, investors hoped these other assets would help offset some of the value destruction.
Here's how they did.
Winner: pet rocks
Sorry, haters. Gold was one of the best alternative ETFs in the selloff, returning 2.5 percent in the past month as the S&P 500 fell 5 percent. This outperformance came as gold bashing reached a fever pitch, with articles calling gold a pet rock. Or just rocks.
And the negative sentiment made sense, with gold ETFs down 7 percent through the end of July. That was a continuation of the 36 percent loss in gold's price over the past three years, a period when the largest gold ETF, SPDR Gold Shares (GLD), saw $25 billion in outflows.
The precious metal may seem an obvious candidate to weather a big selloff, but it's not a sure thing. Gold isn’t inversely correlated to the stock market, unlike the volatility index (the VIX) or ETFs designed to return the inverse of the market's performance. Rather, it has no correlation at all, which means it typically goes up and down independent of the stock market. Still, it does tend to be used by investors as a safe haven in periods of extreme market turmoil, which is why it's a popular portfolio diversifier. In the 18 months during the 2008-09 financial crisis, the metal rose 11 percent over a period where stocks were down 35 percent. And it came through in the latest selloff:
ETFs that track platinum and copper also held up well. The ETFS Physical Platinum Shares (PPLT) and the iPath Bloomberg Copper Subindex Total Return ETN (JJC) both rose more than 3 percent in the past month.
Among the hedge fund strategies tracked by ETFs, the ones that worked best in the selloff were those with strategies that involve shorting stocks. The chart below shows the ProShares RAFI Long/Short (RALS), which was up almost 1 percent.
RALS screens 1,000 stocks on such fundamentals as cash flow and dividends. It goes long on (bets on) the top 20 percent of that list and shorts the bottom 20 percent. It is equal parts long and short, which lessens volatility. Witness the lack of movement relative to the stock market in the chart above. In the past month, RALS benefited more from its short bets than from its long bets.
The QuantShares US Market Neutral Anti-Beta Fund (BTAL), which also takes an offsetting short position in the stock market, was up 1 percent as well.
Loser: broad-based commodity ETFs
No alternative ETF fell more than the stock market, but many were down nonetheless and probably disappointed investors. For example, broad-based commodity ETFs, which are bought as portfolio diversifiers, didn’t deliver much. The $2.5 billion PowerShares DB Commodity Index Tracking Fund (DBC) was down 1 percent. And the $830 million PowerShares DB Agriculture Fund (DBA) was down nearly 3 percent in the past month.
Loser: multi-strategy ETFs
One of the biggest letdowns came from one of the most popular hedge fund replication ETFs, the $1 billion IQ Hedge Multi-Strategy Tracker ETF (QAI). It was down nearly 2 percent.
QAI, one of the most complex ETFs, attempts to replicate the return characteristics for six hedge fund strategies. A mathematical model analyzes hedge fund performance patterns to identify asset classes being used by hedge funds. The ETF then invests in liquid proxies—broad-based ETFs—for those asset classes to try to get similar performance. QAI was hurt by its heavy weightings in high-yield debt and emerging-market ETFs.
Perhaps QAI shouldn't be categorized as an alternative ETF at all. It has an 80 percent correlation with the movements of the S&P 500. This is in contrast to the near-zero correlation with the stock market of GLD, RALS, and BTAL. Correlation is an underrated metric. It can help investors figure out which ETFs are truly alternative.