Author: Jason Hall | February 18, 2019
Looking beyond just a balanced stocks and bonds portfolio
For the vast majority of people, building a portfolio that’s primarily made up of large-cap U.S. stocks and bonds -- and gradually increasing the percentage of your investments that are in bonds as you near retirement -- is a tried-and-true strategy that delivers the best long-term returns during your working years while protecting your nest egg when you leave the workforce.
But that doesn’t mean other alternatives to the traditional large equity and stable fixed-income mix aren’t worth considering.
The reality is, it’s only been in recent years that the average investor has had access to alternative investments in the form of exchange-traded funds, or ETFs. While there are plenty of alternative ETFs most retail investors should avoid, such as triple-leveraged inverse volatility strategies and most commodity futures (because it takes pretty specialized knowledge to invest in these areas with any success), ETFs that give investors concentrated exposure to certain industries or assets can help deliver better returns.
Let’s take a closer look at 10 alternative ETFs that could be a perfect way to round out your portfolio, so long as you invest within your risk tolerance for potential losses
High hopes for cannabis
Pot stocks have been all the rave for the past couple of years. Understandably so, considering the immense growth potential for the cannabis industry on a global basis. However, marijuana remains illegal in the U.S. at the federal level, something that will continue to weigh on the prospects for the industry for potentially years to come.
Of course, that hasn’t stopped speculators from driving up the price of many companies in the space, a number of which operate legally in other countries such as Canada, or participate in other legal businesses in the U.S., including ironically both healthcare and tobacco.
However, many of the best-performing pot stocks have seen their prices surge almost entirely on speculation of their futures, not necessarily their material returns so far. This make it quite risky to invest directly in individual companies in the space.
That makes ETFMG Alternative Harvest ETF (NYSEMKT: MJ) an excellent way to participate in the future of cannabis, while reducing the downside risk of picking a single stock that flops. This ETF is comprised of just over 30 different companies, spreading out that risk substantially.Of course, investing this way comes at a cost; the fund manager takes a 0.75% annual expense ratio to run the fund, which is about eight times more expensive than a cheap S&P 500 index fund.
Profit from the winners and losers of the e-commerce mega-trend
There’s little doubt that e-commerce is a huge trend. It’s also very early in the story, with online sales only accounting for about 10% of global retail transactions. Furthermore plenty of brick-and-mortar retailers are combining e-commerce with in-store shopping, while others struggle. Not sure how to profit from this trend? Besides owning the top e-commerce companies like Amazon.com (NASDAQ:AMZN) and Shopify (NASDAQ:SHOP), taking a long/short approach can result in even juicier returns.However, shorting individual stocks can require a substantial amount of capital and leave retail investors significantly exposed to big losses if you end up on the wrong side of a short bet. The ProShares Long Online/Short Stores ETF (NYSEMKT:CLIX) is one way to participate in a long/short strategy on the future of retail in a more balanced way. The fund takes 100% long positions in leading online retailers, with 50% short position on U.S. retailers heavily reliant on physical stores and lacking a clear e-commerce strategy. The strategy worked out very well in 2018, with the fund delivering 6.9% in total returns, while the S&P 500 broke an eight year streak of positive returns and lost 5%. You’ll pay ProShares a 0.65% expense ratio to run the fund, but if it continues to deliver market-beating returns, it could be money well spent.
Profit from dividend growth with less risk to stock market volatility
One of the better long-term investment strategies out there is based on dividend growth. Historically, a basket of stocks in companies with a strong record of dividend growth has led to solid returns, often better than the S&P 500 over the same period.
However, there’s still the short-term downside to stock ownership with this strategy, and for investors inching closer to retirement and looking to reduce the volatility of their portfolios while still retaining better upside returns than bonds, the Reality Shares DIVS ETF (NYSEMKT: DIVY) may be a good way to achieve that goal.
The simplest way to explain this fund is that its managers seek “...to deliver long-term capital appreciation based on the growth of dividends, not stock price, of large cap companies.”
Here’s how that’s worked to the upside since the start of 2015, shortly after the fund began trading:
Data source: YCharts.
As you can see, it delivered substantially better returns than bonds, as measured by the Vanguard Total Bond Market ETF (NYSEMKT:BND), though its total returns have trailed a very strong stock market.
However, DIVY isn’t built to beat stocks during bull markets; it’s the mix of lower downside risk versus stocks and higher potential returns than bonds that should make it an appealing investment. During the 2018 market correction which saw stocks fall 20%, DIVY lost less than 7% of its value. In other words, this fund offers an interesting mix of risk/rewards that’s somewhere in between stocks and bonds at current yields, in exchange for a relatively high 0.85% expense ratio for the fund managers.
Can’t invest in a hedge fund? This ETF uses the same strategies
Because of the amount of capital they’re working with, hedge funds are able to utilize a number of investing strategies that are frankly out of reach for 99% of retail investors. While the stark reality is most hedge funds don’t deliver market-beating returns, using a hedged strategy for part of your portfolio can still be beneficial. The JPMorgan Diversified Alternative ETF (NYSEMKT:JPHF) is one tool that’s now in retail investors’ belts.
Using a combination of long investments in stocks expected to outperform and short positions in expected underperformers, this fund looks to profit from both the upside and downside of equities. The fund also looks to profit from opportunities in other assets, including commodities, currencies, and fixed income.
The hedging strategy certainly paid off for JPHF investors during the recent stock market downturn, with the fund only losing about 4% of its value from peak-to-bottom. That’s probably worth the 0.85% expense ratio for some investors, but as with other similar investments it has badly underperformed the S&P 500 during its recent bull run.
Since hedging strategies are not just about big returns, but also limiting downside losses, investors could benefit from this fund’s strategy if the market’s bull run has come to an end for now.
This slightly different hedge-fund strategy fund has delivered better returns
Like the JPMorgan Diversified Alternative ETF on the prior slide, the IQ Hedge Multi-Strategy Tracker ETF (NYSEMKT: QAI) also uses the same tactics and tools to generate returns and hedge risks. However, it does so mainly via investing in various ETFs that meet its objectives. The downside of this approach is that it means higher fees for investors; The fund’s fees are higher, with total operating expenses of 1.01%. However, the fund manager has agreed to waive a portion of fees until August 2019, capping total operating expenses at 0.79% until then.
So far, the IQ Hedge fund has delivered superior returns, up 3.7% compared to 1.9% in total losses for the JPMorgan fund since that fund went public in late 2016:
Data source: YCharts.
As they say, past performance is no guarantee for future results, so caveat emptor either way.
A plug-and-play long/short portfolio
After nearly a decade of historically-great returns, stocks came back down to earth in 2018 with the first year of losses for the S&P 500 and Dow Jones Industrials since 2009. With this run of gains, very few investors with a heavy focus on shorting stocks have done well.
After 2018 killed the bull run, and with a number of macroeconomic concerns on the horizon, there’s reason to believe that a balanced long/short portfolio -- that is, primarily owning high-quality stocks for the long-term, while strategically shorting a select few -- could lead to better returns during weak periods for stocks.If you’re looking to utilize this strategy with a portion of your portfolio, then the JPMorgan Long/Short ETF (NYSEMKT:JPLS) might be worth a look. The fund charges a 0.69% expense ratio, which was surely fine for investors who owned this fund during the market’s recent downturn. While stocks fell almost 20%, during the fourth quarter of 2018, this ETF held its value. Unfortunately it hasn't delivered through the first month and a half of 2019, with its value down 2% while stocks have gained 10%.
Bearish on stocks in the near-term? This might be the fund for you
The stock market spends most of its time going up. According to recent studies, stocks go up about 70% of the time, which is one of the reasons why the old saw, “time in the market beats timing the market” has proven absolutely true.
However stocks most certainly do have the occasional downturn, as investors were reminded in last year’s fourth quarter. And while you probably (read:definitely) shouldn’t be looking to get out of stocks and short the market, the WisdomTree Dynamic Bearish U.S. Equity Fund (NYSEMKT: DYB) is a good way to replicate a long/short strategy with some of your holdings. Like many other alternative strategies, this fund has underperformed versus the S&P 500 in recent years, but it’s also a strategy designed to hedge against downside losses in a down market.
Taking a small position in this ETF could be a great way to mitigate short-term losses in your stock portfolio, while profiting from that downside without actually selling off any of your long-term stock investments.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jason Hall owns shares of Amazon and Shopify. The Motley Fool owns shares of and recommends Amazon and Shopify. The Motley Fool has a disclosure policy.