Patti: Volatility Proves Hedge Fund ETFs Work

April 30, 2013

Patti (cont’d.): The weights of each of the eight sectors can run between 2.5 and 22.5 percent. Every month, we’re buying low and selling high for each sector. That solves the constant-overweight in energy. Then the key is, How do we reduce the high volatility typical of equity-based commodity ETFs and improve upon the diversification benefits of equity-based commodity products?

What we did is a constant 20 percent short position in the product, half against the S&P 500 [domestic equities], half against MSCI EAFE [international equities]. The short is rebalanced to 20 percent every month. That reduces volatility and it also reduces your correlation to broad equity markets. If you go back and look at the performance, GRES has been the best-performing broad commodity ETF on the market.

IU: Broad-commodity ETFs haven’t been performing too well. Has GRES been performing positively, unlike the others?

Patti: No, year-to-date performance has been rocky just like the rest of the commodity sector. GRES will generally follow the overall trajectory of the other commodity ETFs. But if you look at performance over most periods of time versus any of the other products in the marketplace or versus the benchmark Dow Jones-UBS Commodity Index, you’ll see quite a big performance gap to our benefit—but also, importantly, with lower volatility.

IU: Let’s talk about gold, because that’s a hot topic right now. How do you explain what happened a few weeks ago?

Patti: Well, I think it’s something many people were looking for, for quite a bit of time, since the gold trade has been crowded for some time. Gold, at first, was going up because of the volatility in the market. People look at it as a safe haven. Then they were looking at it as a hedge against inflation. The gold market had really just become a bubble, in my opinion.

It just seems, as with anything else, it ran up very quickly in a very short amount of time well beyond historical norms. If you look at returns in a band over time, it broke through that band a long time ago. I think a pullback is healthy. And gold as an asset class is a good thing. People should be invested in gold. Regarding whether they should be invested directly in gold as a stand-alone asset class or part of a broader commodity strategy, I would argue the latter. I’m an index guy, so I think broad and cheap is typically a better approach.

Patti: Have you contemplated actively managed ETFs?

Patti: We’ve been very fortunate to have received exemptive relief for active ETFs. We have broad capabilities there. We will certainly be using those capabilities.

IU: You have 11 ETFs in the market. Are you looking to expand the product line?

Patti: We’ll be thoughtfully expanding the product line for sure. But what you won’t see from us is launching a whole bunch of products and hoping something is going to stick. We’re really trying to make a difference in the industry. So we think less is more.

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