Liquid Alts: Myth vs. Reality

by: , Chief Investment Officer and Managing Director | IndexIQ

It’s been nearly a decade since the launch of the IQ Hedge Multi-Strategy ETF (QAI), the first (and still the biggest) liquid alternative Exchange Traded Fund. What made it a compelling idea then makes it a compelling idea now: the opportunity to access an institutional-quality investment strategy with the potentials to improve portfolio diversification and provide risk mitigation during periods of market volatility.

In the years since QAI became available, dozens of new liquid alt ETFs have been introduced incorporating a broad range of strategies that includes merger arbitrage, market neutral, long/short, macro, event-driven, and inflation protection. These funds now hold billions of dollars in assets. Still, misunderstandings remain about how they work, and where they fit in an investor’s portfolio. To start the New Year, we thought it might be a good time to address some of the more common myths:

  • They’re too complex. Like most other ETFs, liquid alts are rules-based products with the strategies detailed in the fund’s prospectus. The IndexIQ liquid alt family is passively managed, meaning that they track an index and seek to capture hedge fund “beta” – the broad market returns inherent in the strategies – not idiosyncratic manager performance. As such, they don’t invest in hedge funds or seek to replicate the day-to-day trading strategies of hedge fund managers. The underlying investment vehicles are generally other ETFs. The ETFs themselves trade daily and the holdings are there for anyone to see. So, while the tools used to create the underlying index may be highly sophisticated, the execution is straightforward.
  • They’re too expensive. Hedge funds are notoriously pricey. Though the traditional “two and twenty” active manager model (a two percent asset-based management fee with 20 percent of the profits going to the manager) has been under pressure, fees remain a major drag on returns for many funds. But that’s not the case with liquid alternatives, where the fees more closely reflect the low-cost structure inherent in ETFs. Money not spent on management and performance fees is available for capture by investors.
  • They haven’t been around long enough to prove themselves. QAI will turn 10 years old this spring, and has been through multiple significant market gyrations, including the 2010 Sovereign Debt Crisis, the Taper Tantrum in 2013 and, most recently, the December 2018 sell-off which saw the S&P 500 Index decline by more than 9% in the month. Since inception, the maximum drawdown for QAI has been -7.88% compared to -36.13% for the S&P 500 and -10.05% for the HFRI Fund of Funds Composite Index.

In 2009, liquid alt ETFs were a new idea, supported by substantial research but unproven in the marketplace. That’s no longer the case for the pioneers like QAI and MNA – the IQ Merger Arbitrage ETF. While past returns are no guarantee of future results, the record being built by funds like these suggest that well-constructed liquid alts have the potential to perform as expected during times of market stress. In light of this, advisors and investors should consider taking a fresh look at some of the myths and misunderstandings that have developed around this asset class.

IQ Hedge Multi-Strategy Tracker ETF Standardized Performance (%) as of 12/31/2018

QTD

YTD

1 Year

3 Year

5 Year

Since Inception

(3/25/2009)

IQ Hedge Multi-Strategy Tracker ETF (NAV)

-4.01

-3.22

-3.22

1.16

0.74

2.52

IQ Hedge Multi-Strategy Tracker ETF (Price)

-4.11

-3.32

-3.32

1.15

0.69

2.51

Returns represent past performance which is no guarantee of future results. Current performance may be lower or higher. Investment return and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Visit nylinvestments.com/etfs for the most recent month-end performance.

Fund Expenses: Management Fee 0.75%; Acquired Fund Fees and Other Expenses 0.26%; Total Annual Fund Operating Expenses 1.01%; Expense Waiver/Reimbursement -0.22%; Total Annual Fund Operating Expenses After Waiver/Reimbursement 0.79%. As stated in the Fund’s prospectus, the management fee of 0.75% is expressed as a unitary fee to cover expenses incurred in connection with managing the portfolio. Performance reflects a contractual fee waiver and/or expense limitation agreement in effect through 8/31/19, without which total returns may have been lower. This agreement renews automatically for one-year terms unless written notice is provided before the start of the next term or upon approval of the Board.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the entire market or a benchmark.

maximum drawdown is the maximum loss from a peak to a trough of a portfolio, before a new peak is attained. It is also an indicator of downside risk over a specified time period.

The 2010 Sovereign Debt Crisis (also referred to as the European Debt Crisis) began at the end of 2009 when several eurozone member states were unable to repay or refinance their debt without the assistance of third parties.

The 2013 Taper Tantrum resulted from the U.S. Federal Reserve’s gradual reduction of the amount of money it was feeding into the economy, resulting in drastically increased bond yields when investors rapidly drew money out of the bond market.

The S&P 500® Index is widely regarded as the standard index for measuring large-cap U.S. stock market performance.

The HFRI Fund of Funds Composite Index (HFRI FoF Composite Index) is an equally weighted hedge fund index including over 650 domestic and off-shore fund of funds. The index is rebalanced monthly with performance updates three times per month.

About risk

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

QAI:

The Fund’s investment performance, because it is a fund of funds, depends on the investment performance of the underlying ETFs in which it invests. There is no guarantee that the Fund itself, or any of the ETFs in the Fund’s portfolio, will perform exactly as its underlying index. The Fund’s underlying ETFs invest in: foreign securities, which are subject to interest rate, currency exchange rate, economic, and political risks. These risks may be greater for emerging markets. Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible. In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Leverage, including borrowing, will cause some of the Fund’s underlying ETFs to be more volatile than if the underlying ETFs had not been leveraged. The Fund may experience a portfolio turnover rate of over 100% that will increase transaction costs and may generate short-term capital gains which are taxable.

MNA:

Certain of the proposed takeover transactions in which the Fund invests may be renegotiated, terminated or involve a longer time frame than originally contemplated, which may negatively impact the Fund’s returns. The Fund’s investment strategy may result in high portfolio turnover, which, in turn, may result in increased transaction costs to the Fund and lower total returns. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks. These risks may be greater for emerging markets. Diversification does not eliminate the risk of experiencing investment losses. Stock prices of mid and small capitalization companies generally are more volatile than those of larger companies and also more vulnerable than those of larger capitalization companies to adverse economic developments. The Fund is non-diversified and is susceptible to greater losses if a single portfolio investment declines than would a diversified fund. The ETF should be considered a speculative investment with a high degree of risk, does not represent a complete investment program and is not suitable for all investors. The Fund may experience a portfolio turnover rate of over 100% that will increase transaction costs and may generate short-term capital gains which are taxable.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

Consider the Fund’s investment objectives, risks, and charges and expenses carefully before investing. The prospectus and the statement of additional information include this and other relevant information about the Fund and are available by visiting nylinvestments.com/etfs or calling 888-474-7725. Read the prospectus carefully before investing.

Fund shares are not individually redeemable and will be issued and redeemed at their NAV only through certain authorized broker-dealers in large, specified blocks of shares called “creation units”, and otherwise, can be bought and sold only through exchange trading. Creation units are issued and redeemed principally in-kind.

New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, located at 51 Madison Avenue, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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