New ETF Offers Hedge Fund Tactics to Masses

The IQ Hedge Multi-Strategy Tracker ETF uses hedge fund strategies typically available to wealthy investors.
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Hedge funds

are reserved for ultra-rich investors and institutions, but a new exchange traded fund brings their sophisticated strategies to average people.

The

IQ Hedge Multi-Strategy Tracker ETF

(QAI) - Get Report

started trading last week. It replicates the tactics

hedge funds

are famous for, such as short selling and arbitrage, by investing in other ETFs.

Hedge funds

are known to generate returns even if the stock market drops, but that performance usually comes at a high cost. The IQ Hedge fund takes 0.75% for fees and costs, topping the expense ratios of more common funds like

PowerShares QQQ

(QQQQ)

and the

SPDR S&P 500 ETF

(SPY) - Get Report

, which charge 0.2% and 0.1%, respectively. But if the fund delivers better risk-adjusted returns than a stock ETF, it might be worth the higher cost.

The IQ Hedge fund relies on a complex scoring system to guide its asset allocation, which can change as often as monthly. Most of the ETF's assets are invested in funds that track broad, common indexes, such as the

Morgan Stanley Capital International EAFE Index

. The fund creates short positions by buying "inverse" funds, like the

ProShares UltraShort Russell 2000

(TWM) - Get Report

, which bet on falling markets.

It's difficult to figure out the strategy the IQ Hedge fund is going after with each underlying ETF. For example, it has a small amount invested in the

ProShares UltraShort Euro fund

(EUO) - Get Report

. Is this move related to global events or something else?

Bond ETFs, which have been the best place to be, account for the largest portion of assets. A quarter of the fund is invested in the

iShares Barclays Aggregate Bond Fund

(AGG) - Get Report

, its largest holding. The No. 2 holding is the

iShares Barclays 1-3 Year Treasury Fund

(SHY) - Get Report

with 18% of assets.

Emerging-markets bets make up 13% of the IQ Hedge fund's assets. That amount is divided between the

iShares MSCI EAFE Emerging Market Fund

(EEM) - Get Report

and the

Vanguard Emerging Market ETF

(VWO) - Get Report

.

Investors should consider two caveats before investing in the IQ Hedge fund. First, a manager that uses hedge fund-style strategies should have free reign to take long or short positions in specific countries and industries, but that might be hard to achieve with ETFs that track broad indexes. The fund invests in only a couple of narrowly focused funds, which buy companies in certain regions or sectors.

Second, the fund buys ProShares UltraShort funds to create short exposure, bets that stocks will fall, instead of the traditional method of selling borrowed securities. But there's no guarantee these inverse funds will double the declines of their indexes.

I'm a big fan of what the IQ Hedge ETF tries to do but I suggest giving it a few months to prove itself.

At the time of publication, iShares Barclays 1-3 Year Treasury Fund was a client or personal holding.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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