ETF Talk: A New Way to Invest in Hedge Funds

The market crash of 2008 was disastrous for most private investors, mutual funds, brokerage accounts and 401(k)s — but not for certain well-managed hedge funds. Indeed, individual hedge funds defied the financial fallout by using strategies that generated huge profits in what otherwise seemed to be the worst year for investors since the Great Depression.

Hedge funds have been out of the reach of most investors since they typically cater to the very well-heeled. Such funds are extremely hard for most people to access, and they involve the payment of high management fees. But now those barriers are lifting through the introduction of a new exchange-traded fund (ETF) that replicates the strategies and returns of successful hedge funds.

One such fund, launched by financial services firm IndexIQ, is called the IQ Hedge Multi-Strategy Tracker (QAI). This ETF aims to replicate six hedge fund investment styles: buying long/selling short, global macroeconomic trends, market neutral, event-driven, fixed-income and emerging markets. But instead of buying into hedge funds, QAI buys a basket of ETFs.

Hedge funds typically use a variety of strategies to turn profits. Such funds "hedge" their bets through short-selling, derivatives and futures contracts, leverage and diversification. Just how successful were these strategies for the top hedge funds last year? Industry veteran and star investor George Soros managed to eke out a 10% profit for his fund in 2008. However, this gain seems paltry compared to rising financial industry investment star, John Paulson, who tripled his fund’s assets from $12 billion to $36 billion from June 2007 to November 2008.

That growth was achieved by shorting mortgage-backed securities — in the midst of the greatest decline in market history. A couple of Paulson’s funds were up more than 350% last year.

Since its inception on March 25, 2009, QAI is up 2.80%. More importantly, the ETFs that QAI tracks were down just 4.1% in 2008, compared to a 38% slide in the S&P 500. And despite being a little more expensive than other ETFs with an expense ratio of 1.09%, QAI seems decidedly more cost-effective than actual hedge funds that charge a 2%-of-assets fee, as well as 20% in performance fees.

While I am optimistic about this ETF’s future, I want to track QAI’s performance before making any kind of buying recommendation. I will, however, be keeping a close eye on QAI, as it could represent a nice addition to a diversified portfolio.

If you want further guidance about which ETFs to trade, check out my ETF Trader service by clicking here. As always, I am happy to answer any questions that you have about ETFs. To send me your questions, simply click here. I will try to follow up in a future ETF Talk.