QMN: New Market Neutral ETF from Index IQ Has Trouble Measuring Up

| About: IQ Hedge (QMN)
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Index IQ added to its lineup of hedge fund replication ETFs on October 4, 2012 with the launch of IQ Hedge Market Neutral Tracker ETF (NYSEARCA:QMN). The new ETF seeks to track, before fees and expenses, the performance of the firm’s own IQ Hedge Market Neutral Index. QMN does not invest in hedge funds. Instead, it attempts to mimic the performance characteristics of market neutral hedge funds using a fund-of-funds approach with other ETFs.

Market neutral hedge funds typically invest in both long and short positions in multiple asset classes while minimizing exposure to systematic risk. These strategies seek to have zero “beta” exposure to one or more systematic risk factors, which could include the overall stock market, economic sectors or industries, market cap, region, or country. In theory, market neutral strategies that effectively neutralize market exposure are not impacted by directional moves in the market.

Top fund holdings include Vanguard Short-Term Bond ETF (NYSEARCA:BSV) 26.0%, iShares Barclays 1-3 Year Treasury Bond (NYSEARCA:SHY) 25.1%, iShares MSCI EAFE Index Fund (NYSEARCA:EFA) 8.2%, Vanguard Total Bond Market ETF (NYSEARCA:BND) 8.2%, iShares Barclays Short Term Treasury (NYSEARCA:SHV) 7.8%, SPDR Barclays Convertible Securities ETF (NYSEARCA:CWB) 7.5%, and iShares Barclays Aggregate Bond (NYSEARCA:AGG) 7.4%.

The net expense ratio will vary over time based on the fees of the ETFs in QMN’s portfolio. The current expense ratio of 0.99% has 0.24% designated as acquired fund expenses. Additional information can be found on the overview page and in the prospectus (pdf).

Analysis/Opinion: The underlying index has 1-year and 3-year performance figures of 5.25% and 4.03% annually as of 9/30/12. Assuming perfect tracking, the fund’s theoretical returns would have been 4.5% and 3.3%. These are less than the iShares Barclays Aggregate Bond (AGG) returns of 5.0% and 5.7%. No risk data for the underlying index could be found. If you choose to compare these returns to stocks, the SPDR S&P 500 ETF (NYSEARCA:SPY) returns for the same periods were 30.1% and 13.1%.

Rather than taking a long/short approach to market neutrality, the underlying index attempts to mimic market neutral characteristics by investing primarily in bond ETFs at this time. The only inverse equity exposure for the index consists of a 1.0% allocation to ProShares UltraShort Russell 2000 (NYSEARCA:TWM).

Far from being market neutral, the current asset class exposures are Bonds 77.0% (84.2% if convertibles are included), Equities 11.0%, Hybrids 7.2%, and Currencies 3.0%. There are about 35 products listed in the Alternative Strategy section of the ETF Field Guide. For the most part, their performance has been underwhelming. However, a full market cycle is necessary for a more objective analysis.

Disclosure covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.