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The Myth vs. Realities of Liquid Alts

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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.

Related: Making Sense of the Investing Year Almost Past

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.

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