Alternatives and Absolute Return with ETFs

by: David McMillan

Over the years, absolute return approaches have formed the cornerstone of many of our client portfolios, traditionally through hedge fund of fund vehicles and separate account managers. It was with great fanfare then, that we rolled out a range of new ETF portfolios to our clients earlier this year that removed many of the down side operational risks to hedge fund investments with the potential of achieving absolute returns.

By creating risk based portfolios of approximately 20 ETFs with the liquidity, transparency, low cost and tax efficiency that the ETF world allows us to deliver, investors are able to fully engage in the investment process by having complete look through to the portfolio construction.

This allows them to gain a better understanding of how the investments relate to events they hear about in the media and experience in their own lives, packaged in one of the most easily understood investment vehicles available today.

As active managers, one of the portfolios that has appeal in difficult market conditions is the All Seasons portfolio launched at the start of the year, including the following ETFs:

  • Powershares Buyback Achievers (NASDAQ:PKW)
  • Powershares FTSE RAFI Developed Mkts ex-US (NYSEARCA:PXF-OLD)
  • Wisdom Tree Emerging Markets Small Cap Fund (NYSEARCA:DGS)
  • iShares MSCI Singapore Index Fund (NYSEARCA:EWS)
  • iShares South Korea Index Fund (NYSEARCA:EWT)
  • iShares Lehman TIPS bond (NYSEARCA:TIP)
  • Powershares 1-30 year Laddered Treasury (NASDAQ:PLW)
  • Powershares Emerging Markets Sovereign (NYSE:PCY)
  • iPath Dow Jones – AIG Grains Total Return ETN (JJG)
  • iPath Dow Jones – AIG Agricultural Total Return ETN (NYSEARCA:JJA)
  • Path S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL)
  • State Street Tracks Gold Index (NYSEARCA:GLD)
  • Powershares Dow Jones Ultra Short Real Estate – 2x (NYSEARCA:SRS)
  • Powershares Deutsche Bank US Dollar Bearish Fund (NYSEARCA:UDN)
  • Eaton Vance Risk Managed Diversified Equity Income Fund (NYSE:ETJ)
  • Powershares Ultra Short FTSE/Xinhua China 25 (NYSEARCA:FXP)
  • Powershares Ultra Short Consumer Services (NYSEARCA:SCC)
  • Powershares Global Water Portfolio (NASDAQ:PIO)
  •  Powershares International Listed Private Equity (PFP)
  • Powershares Deutsche Bank G10 Currency Harvest Fund (NYSE:DBV)

Some of the key elements making up the allocation strategy were as follows:

  • Maintain core domestic and equity positions: PKW, PXF, DGS
  • To benefit from a bullish commodities position: JJA, JJG, OIL, GLD
  • To take advantage of the weakening dollar: UDN, DBV
  • Domestic and International hedging: SCC, FXP, SRS
  • Inflation Protection, TIP, GLD, OIL
  • Fixed income growth, PLW, TIP, PCY
  • Satellite specialty positions: EWS, EWT, JJG, PIO

By blending a range of traditional domestic and international equity positions, diverse bond ETFs, with a range of non correlated and specialty ETFs covering currency, commodities, country specific allocations and several short positions allows for the development of a durable portfolio able to weather tough market conditions. Taking a core-satellite approach also allows for ‘best ideas’ to be incorporated without sacrificing the stability of the allocation.

As the ETF universe continues to expand and more specific ETFs continue to be released, this can mean only greater opportunities for flexible absolute return portfolios.

Disclosure: Author holds a long position in all of the ETFs listed above.