Like their mutual fund counterparts, alternative-focused ETFs comprise a vast range of investment strategies, making it impossible to issue a general assessment. Instead, investors must look at an ETF individually and, in some cases, consider how long and when it was held.
Offerings have grown from just one in 2005 to 326 this year. The number reached its apex in 2011, when there were 332. Assets in alternative ETFs have likewise increased, starting in 2005 with about USD 89 million and growing to USD 46 billion by August 2013, according to investment research company Morningstar.
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"It's clear that awareness and consideration of this expanded category of ETFs is growing," says Steven Sixt, director of research and consulting at Cogent. "Their lower [fees], their transparency and liquidity are attractive qualities. And they can access an alternative strategy that would otherwise be unavailable."
Some observers expect flows to grow and fund managers to increase exchange-traded product line-ups to cope with the interest.
This year Cerulli Associates asked ETF sponsors how they would project new products and found 45 percent said they would focus on alternative strategies.
Nine per cent said it was a secondary focus. What this means in practice may shift in coming years. Some note the environment seems primed for actively managed ETFs - the newest evolution of the products. "Within the ETF space, the number one alternative strategy is commodity funds," says Pamela DeBolt, a senior analyst at Cerulli. "They were very popular post-financial crisis. But now, even though the majority of ETF assets are in commodity products, that's not where all the money is going ... we may see strategies that are more popular in an active approach."
Some alternative ETFs have been wildly successful, others disappointing. In many cases, to understand how an alternative ETF affected a particular investor, it is important to learn the size of the investment and when it was made.
Direxion's Daily Small Cap Bull 3X Shares ETF returned 80.8 percent for the year ending in early September, while its Daily Gold Miners Bull 3X Shares returned -86.9 percent for the same period, according to Morningstar.
It might appear at first glance that one fund's performance was outstanding and the other's was terrible. Both are leveraged funds, seeking three times the return of their benchmark indices. These are respectively the Russell 2000, which returned about 24 per cent for the same period, and the NYSE Arca Gold Miners Index, which returned about -39 per cent.
Both funds beat those returns, fulfilling their aim. Also, both are meant to be held for just one day. So how either impacted a portfolio would depend on how much was invested and on what day.
If investors are using the products as intended, then they are relatively cheap and an easy way to gain access or get leverage, says Abby Woodham, an ETF analyst at Morningstar. "But if you hold it on a longer time period, it doesn't work, and you might say, 'This is broken'," she adds.
Alternative ETFs are like conventional stock or bond ETFs, in that they track an asset or basket of assets in the exchange market. A currency ETF tracks a currency or a basket of currencies, a commodity ETF tracks a specific commodity or basket of commodities.
The products can give investors inexpensive exposure to the alternative investments. The term "alternative ETF" can also refer to an "alternative" strategy, such as the Direxion leveraged ETFs.
Approached as a single category, the 20 largest alternative ETFs returned 0.1 per cent for the year ending September 9. That is up from -2.9 percent in 2012, -11.4 percent in 2011 and -5.3 percent in 2010. But the story is more nuanced when each fund is assessed individually.
Alternative ETFs are "a really, really broad category group," Ms Woodham says. "We have everything from leveraged funds to currency funds, so it's hard to make a sweeping statement about them."
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