Exchange-traded funds have been revolutionary for small investors, providing low-fee, diversified access to markets.
Yet ETFs providing exposure to alternative assets – such as real estate, infrastructure and hedge funds – are generally not on Canadian investors’ radar, says Karl Cheong, portfolio manager with First Trust Portfolios Canada.
But these investments are certainly worth a look because they offer cheap, liquid access to strategies that are uncorrelated to broader markets, he says.
If you’re looking to diversify holdings beyond the traditional North American focus of equities and bonds, here are a few ETFs to consider.
ETFs offering exposure to alternative assets
Among the most common alternative assets are real estate and infrastructure. Two good options for investors are the Vanguard Real Estate ETF (VNQ) and the iShares Global Infrastructure (IGF), says Todd Rosenbluth, director of ETF and mutual fund research with CFRA in New York.
Many investors own Canadian real estate investment trusts (REITs), but the VNQ offers ultra-low-cost, diversified exposure to U.S. real estate with a management expense ratio (MER) of 0.12 per cent.
“Real estate is a defensive sector that holds up well in volatile markets,” he says, but it can lag if interest rates rise sharply. Some of that downside has been evident this year as the Federal Reserve has hiked rates multiple times.
Rather than investing in hard infrastructure assets, IGF provides exposure to energy, industrials and utilities firms that stand to benefit from government spending on infrastructure. “Many political leaders agree on the need to invest to modernize roads, bridges and the utility system,” Mr. Rosenbluth says.
The downside is politics often get in the way. He points to the United States, where infrastructure spending was a key promise for Democrats and Republicans during the 2016 election. “But we’ve seen little progress to date,” he says.
ETFs offering exposure to alternative geographies
Emerging markets aren’t typically considered alternative assets. Yet Toronto portfolio manager Tyler Mordy argues they fit the bill for many Canadians, who have a strong home bias in their portfolio and a dearth of emerging market exposure.
“That’s why we consider any asset that is not broadly represented in Canadian portfolios as ‘alternative,’” says Mr. Mordy, who is president and chief investment officer at Kelowna, B.C.-based Forstrong Global Asset Management Inc.
Still, he argues a more targeted approach is better than buying a broad-based ETF that includes the largest companies across all emerging markets. He suggests the KraneShares CSI China Internet ETF (KWEB) and VanEck Vectors Vietnam ETF (VNM).
While China’s stocks have lost value in recent weeks amid its trade war with the U.S., easing Chinese fiscal policy along with growing domestic demand, which is the primary driver of its internet companies, should cushion the blow for this segment of tech companies, Mr. Mordy argues.
Still, “Trump’s trade war with China continues to be a key risk,” he says. Further to that point, the fund is experiencing the negative effects of the tussle and is down more than 20 per cent YTD.
The VNM steers investors to Vietnam, which has many upsides. Chief among them is increased investment from China, which is moving away from low-cost manufacturing and looks “to tap into its [Vietnam’s] educated and relatively inexpensive work force.” Vietnam’s middle class is also growing quickly, he adds.
Among the risks is volatility, similar to that of other early-stage, rapidly growing economies. In addition, Vietnam’s growth is subject to the fate of other, much larger emerging markets, such as China. Consequently, the fund is down about 15 per cent year to date.
ETFs offering exposure to alternative strategies
The next 10 years in the markets are unlikely to be like the past decade, Mr. Cheong says, because “as interest rates continue to rise, fixed income is likely to be negative and equity will be more volatile.” One way for investors to manage these challenges is with ETFs mimicking hedge-fund strategies that provide alternatives to the buy-and-hold approach.
The QAI is an “all-in-one product combining many hedge fund strategies – long/short, commodities, trend following, global macro – into one solution.” It offers conservative returns as well as downside protection amid rising rates and increased volatility.
With the MNA, investors get access to a strategy that shorts companies announcing acquisitions of other companies while taking a long position in the firms being acquired. The idea is that buyers “are usually penalized because they are overpaying,” Mr. Cheong says. At the same time, the acquired companies usually see an uptick in their stock price in the run-up to the official takeover. The result has been a steady five-year return of about 4 per cent.
Yet while these ETFs provide stable returns amid uncertain conditions, they will lag broader markets if the Federal Reserve reverses course, he says. Consequently, if interest rates fall in the future, investors could expect the MNA and QAI, which averaged about 1 per cent over the past five years, to trail a broad-based ETF like the iShares Core S&P 500 ETF (IVV), which roughly returned 11 per cent annually over the same span.