These investments are great additions for diversifying a traditional portfolio of stocks, bonds and cash.
Traditional portfolio management principles dictate that there are three general asset classes: stocks, bonds and cash. Investors can mix and match these assets in various proportions to suit their risk tolerance, investment objectives and time horizon. However, a fourth category of assets does exist: so-called alternative investments. These include things like precious metals, real estate, private equity, commodities, hedge funds, managed futures, derivatives and even cryptocurrencies. Alternative investments can often have a low or even negative correlation with stocks and bonds, which makes them great for diversification. A small allocation to alternative investments can help reduce risk and hedge against risks like market crashes, rising interest rates, or high inflation. Here is a list of seven alternative investments available in exchange-traded fund, or ETF, form.
iMGP DBi Managed Futures Strategy ETF (ticker: DBMF)
DBMF is a managed futures ETF. This is a portfolio of futures contracts actively managed by a team of commodity trading advisors, or CTAs. Managed futures are designed to produce non-correlated, positive expected returns irrespective of market conditions. They achieve this using hedge fund-like strategies, which can include long/short, market neutral, global macro, or trend following. Currently, DBMF holds short positions in a variety of U.S. government Treasurys and international currencies, and a long position in crude oil. As an actively managed fund using derivatives, DBMF is quite expensive, with an expense ratio of 0.85%. Still, it’s done its job well so far this year, with a 25.8% return through July 20 while both stocks and bonds fell.
KFA Mount Lucas Index Strategy ETF (KMLM)
KMLM is another managed futures ETF. The ETF holds a portfolio of 22 futures contracts comprising 11 commodities, six currencies and five global bonds weighted by historical volatility. The ETF uses a pure trend-following strategy to capitalize on momentum. Investors who buy KMLM are therefore entrusting its performance to the skill of the CTA team managing it. So far, this has paid off, with KMLM up 33.1% year to date and recording a low-to-negative correlation with major equity and bond indexes. Holding KMLM is rather expensive though, with an expense ratio of 0.95%. Still, this is cheaper than the “2% and 20%” fee structure charged by most hedge funds.
Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)
SPD makes use of put options on the S&P 500, which are derivatives that can soar in value if the underlying index experiences a sharp crash. For every $100 invested in SPD, $96 is invested in a vanilla ETF tracking the S&P 500. The remaining 4% is used to finance a ladder of out-of-the-money, or OTM, put options. The options are selected for convexity, meaning the bigger the crash, the greater the payout. Compared to a regular S&P 500 index ETF, SPD is likely to lag during bull markets, but fall significantly less during a bad crash. Therefore, it may be a good choice for investors with a lower risk tolerance trying to protect their investment. SPD currently costs an expense ratio of 0.28%.
Cambria Tail Risk ETF (TAIL)
Like SPD, TAIL also uses a ladder of OTM put options on the S&P 500 to mitigate the possibility of a bad crash. Unlike SPD however, TAIL allocates most of its holdings to a portfolio of U.S. Treasurys and Treasury-Inflation Protected Securities, or TIPS. The coupons paid by the Treasurys are used by the fund to pay for the premiums charged for buying the put options. TAIL should best be thought of as insurance. During normal low-volatility bull markets, the fund can be expected to lose value slowly as the put options expire out of the money. However, during a bad crash, TAIL can gain sharply in value, like it did in March 2020 during the COVID-19 crash. TAIL costs an expense ratio of 0.59%.
SPDR Gold MiniShares (GLDM)
Investors often buy gold bullion for its perceived use as a store of value and inflation hedge. Gold also has a low correlation with both stocks and bonds, which makes it useful as a portfolio diversifier. Investors can buy physical gold bullion, but this approach can be time consuming and costly in terms of storage and insurance costs. An easier way to gain exposure to gold is via a gold ETF like GLDM. GLDM tracks gold bullion held in secure, audited vaults, with each share of the ETF corresponding to beneficial ownership of that deposit. Best of all, GLDM is extremely cost effective with an expense ratio of just 0.1%, or around $10 in annual fees for a $10,000 investment.
Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)
Thanks to high inflation and supply chain issues, commodities have been one of the best-performing asset classes this year. They also tend to exhibit a low-to-negative correlation with gold, which gives them great diversification potential. An easy way to hold a broad basket of commodities comprising gasoline, crude oil, aluminum, copper, natural gas, gold, wheat, corn, soybeans, zinc, sugar and silver is via PDBC. PDBC also does not spit out an annual K-1 tax form as the ETF is structured as an open-ended fund as opposed to a limited partnership, saving investors significant hassle. However, the ETF has a high yield in the form of return of capital, so it is best held in tax-advantaged accounts. PDBC costs an expense ratio of 0.62% to hold.
ProShares Ultra VIX Short-Term Futures ETF (UVXY)
The strongest hedge against a stock market crash are futures that track the Chicago Board of Options Exchange Volatility Index, or VIX, otherwise known as “Wall Street’s fear gauge.” When markets crash, VIX tends to spike sharply as volatility increases. Because investors can’t buy VIX directly, they have to rely on VIX futures instead, which are derivatives that bet on the future anticipated value of VIX. UVXY holds short-term S&P 500 VIX futures with 1.5 times leverage. The ETF has a strong negative correlation with stocks, making it a good short-term hedge. However, it is a very poor long-term hold. Over time, the mean-reverting nature of VIX and volatility decay cause UVXY to inevitably lose value. UVXY is best suited for short-term traders who believe the market is likely to crash soon. It is also costly with an expense ratio of 0.95%.
7 alternative investments that can lift your portfolio:
— iMGP DBi Managed Futures Strategy ETF (DBMF)
— KFA Mount Lucas Index Strategy ETF (KMLM)
— Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)
— Cambria Tail Risk ETF (TAIL)
— SPDR Gold MiniShares (GLDM)
— Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)
— ProShares Ultra VIX Short-Term Futures ETF (UVXY)
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7 Alternative Investments That Can Lift Your Portfolio originally appeared on usnews.com
Update 07/21/22: This story was published at an earlier date and has been updated with new information.
