Hedge Fund ETF Offers Bond Alternative

May 10, 2016

Josh Pierce is director of research and portfolio manager at Boston-based Baystate Wealth Management. Founded in 2010, Baystate has nearly $800 million in assets under management.

The firm predominantly uses ETFs in its portfolios, including the IQ Hedge Multi-Strategy Track ETF (QAI), which Pierce likes for alternatives exposure. ETF.com recently caught up with Pierce to discuss QAI in light of the ongoing debate surrounding hedge fund performance.

ETF.com: You own the IQ Hedge Multi-Strategy Tracker ETF (QAI | C-73), which gives investors hedge fund exposure in an ETF wrapper. What do you like about that ETF?
Josh Pierce: It's the only hedge-fund-beta strategy that's worked for us. We started with other funds, but we ended up going to QAI because we liked the fact that it's transparent—you can easily pull up a list of the underlying ETFs that it owns.

It's also tradable and has good volume, especially compared to other alternative ETFs. It's helped that QAI was ahead of everybody else in terms of coming to market.

We think of alternatives either as risky alternatives or diversification alternatives. We look at QAI like a bond alternative. We think of it just ahead of something like the Barclays Aggregate Index in terms of risk and return.

We're only looking for 3-5% return with a similar volatility metric on it, which is essentially what it's given us. It's slow and steady, which I like.

ETF.com: There's been a lot of negative headlines out there recently on hedge funds, and a lot of the big-name funds have been doing poorly. Does that concern you, or is QAI immune from that?

Pierce: Hedge funds are always getting beaten up for their performance.

If you look at individual hedge funds, which are going long/short, betting on Coke over Pepsi, and trying to figure out whether to be short or long China—that stuff is really hard to do. That's the reason some of those funds have struggled of late.

But if you're looking at it from a more macro picture, and just looking for an asset-allocation-type model with a relatively low expense ratio, it's another story. With QAI, you're paying only 90 basis points, You're not paying that 2/20 [2% fee, 20% of returns] that individual hedge funds charge.

We're happy with it. We bought it in 2012, and it's given us a four-year return in the 3-4% per-year range.

We wouldn't go out and buy an individual hedge fund where you're investing in an individual or a team to figure out where to be long and short. We like this approach that is more neutral to the market movement. It's a relatively efficient way to try to capture the sentiment or the views of the aggregate hedge fund index and optimize it from a risk and return standpoint.

If we were investing and thinking that the hedge fund space should get you 9-10% per year, we wouldn't be happy with it. That was never our expectation.

We like the fact that it's slow and steady. We do think of it as a hedge against bond volatility and equity volatility. In fact, we call it an alternative to a fixed-income strategy.

ETF.com: If an investor chooses to add exposure to something like QAI, what percentage of their portfolio should they be allocating to these types of strategies?

Pierce: The weighting depends on the investment strategy of each individual or client. We also look at QAI as an alternative to either a stock or a bond.

If, for example, we didn't like stocks or bonds because we thought they're both expensive, we would then add more to it. But if we were neutral across the board, we would take a model weight. Our model weight for a moderate, middle-of-the-road-type client is probably around 5%.

If you're more conservative, maybe you have a higher allocation—9% or more. And then if you're more aggressive, you're not going to have a high allocation—0-2%—because an aggressive client isn't looking for this type of return and risk profile.

The hardest part of the alternative space, especially this hedge-fund-replication space, is valuing it. It doesn't have a P/E ratio. It doesn't have an interest rate attached to it. So you're really valuing it relative to your other options.

If we're fully bullish on stocks, we might not own any of it. If we're fully bullish on bonds, we might not own any of it. But that probably would never happen, because there's never been a perfect world like that.

Contact Sumit Roy at [email protected].

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