Inflation, Inflation Everywhere: Newer ETFs Offer Targeted Hedge

Includes: CPI, FLAT, STPP, VXZ
by: Morningstar

By Josh Charney

The three panelists on the new-wave alterative panel all shared their views on how and why investors are crossing into the alternatives frontier. With little agreement among them on what constitutes an alternative asset, Joanne Hill of PowerShares Advisors explained that the definition has changed over time. The current push to alternative investments is partially attributable to strategies heavily employed by endowments for more than a decade. Investors who fear outliving their assets see optimism in the newest lineup of ETFs that offer tools once exclusively reserved for large intuitional players.

A new breed of ETFs attempts to change the playing field by hedging "real" world inflation, explains Adam Patti of Index IQ. Investors can buy CPI (an ETF) to provide investors a real world hedging tool. Tim Edwards of Barclays Capital noted that CPI (the index, not the ETF) doesn't rise fast enough and hasn't accurately tracked typical household expenses such as housing or college. When hedging, Patti believes a common mistake investors make is buying TIPS, or indexed CPI Treasury bonds, as a lattered portfolio is an inadequate hedge. He believes the correct way to hedge is to use a multiasset approach, which encompasses certain types of equities, commodities, and other alternative assets.

As more investors move into the alternatives space, products such as hedge-fund-replication and yield-curve-flatting ETFs will garner more attention. Patti stated that the dirty secret of hedge funds is that they don't trade very often. Hill looked at past SEC fillings and found that the average holding period for hedge funds is 18 months. Armed with past hedge fund data and multifactor models, firms constructed hedge-fund-replication ETFs that mimic the asset class; many have a profile similar to the HFRI. Yield-curve plays are also gaining in popularity, and Barclays now offers two ETFs that allow investors to play the flattening and steeping of the yield curve: FLAT and STPP.

The bull market in bonds for the past 30 is reason for Edwards to believe that past returns in the bond market are not repeatable. Alternative investment products now allow investors to capture yield, but without the interest-rate risk. Volatility is also a concern for many investors, and Edwards notes that investors are turning to VXZ for a longer-term volatility hedge.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.