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Navigating Absolute Return ETFs

NEW YORK (TheStreet) -- Recently a former colleague asked for help trying to sort through the potentially overwhelming number of choices available among exchange-traded funds that target alternative strategies like absolute return and other hedge fund-like strategies. A look at the IndexUniverse ETF finder shows 30 exchange-traded products in the absolute return category of the alternatives asset class excluding leveraged products.

The Global X Top Guru Holdings (GURU) is listed as one of the absolute return choices, but Global X views the fund as a core equity holding. There are still enough choices in the category to make choosing one difficult.

The dominant fund in the alternatives sector is the IndexIQ Hedge Multi Strategy Tracker (QAI), which has $450 million in assets. It blends together several hedge fund strategies including long/short and global macro by using ETFs from various asset classes. The results have been mostly as advertised, inching up slowly with a chart that rarely resembles the stock market. Again that is the point here, slow and steady returns that don't resemble the results of equities.

One popular category judging by the number of funds is merger arbitrage, but the funds have different methodologies and the result can be dramatically different. True to merger arbitrage, the Credit Suisse Merger Arbitrage Liquid ETN (CSMA) goes long the target company and sells the acquirer short subject to certain strategic constraints. The risk to the fund is if an announced deal fails to materialize.

The ProShares Merger ETF (MRGR), on the other hand, will sell short the acquirer only in a stock deal. In a cash takeover, it will go long the target but will not have a corresponding short position. The most recent fact sheet discloses the long exposure at 107%, the short exposure at 22% and 15% in cash. That makes the fund much more vulnerable to the ups and downs of the stock market. At times that will help performance and at other times hurt it.

Year to date, MRGR is down 6% versus a gain of 6% for CSMA. Their fates could easily be reversed, but in terms of a product that reduces stock market exposure, CSMA would be the better choice, but of course it is an exchange-traded note, which is an unsecured debt obligation of the issuing bank.

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