New ETF Offers Hedge Fund Tactics to Masses

• ByRoger Nusbaum, TheStreet.com Contributor
• On 11:00 am EDT, Monday March 30, 2009

Hedge funds are reserved for ultra-rich investors and institutions, but a new exchange traded fund brings their sophisticated strategies to average people.

The IQ Hedge Multi-Strategy Tracker ETF started trading last week. It replicates the tactics hedge funds are famous for, such as short selling and arbitrage, by investing in other ETFs.

Hedge funds are known to generate returns even if the stock market drops, but that performance usually comes at a high cost. The IQ Hedge fund takes 0.75% for fees and costs, topping the expense ratios of more common funds like PowerShares QQQ and the SPDR S&P 500 ETF, which charge 0.2% and 0.1%, respectively. But if the fund delivers better risk-adjusted returns than a stock ETF, it might be worth the higher cost.

The IQ Hedge fund relies on a complex scoring system to guide its asset allocation, which can change as often as monthly. Most of the ETF's assets are invested in funds that track broad, common indexes, such as the Morgan Stanley Capital International EAFE Index. The fund creates short positions by buying "inverse" funds, like the ProShares UltraShort Russell 2000, which bet on falling markets.

It's difficult to figure out the strategy the IQ Hedge fund is going after with each underlying ETF. For example, it has a small amount invested in the ProShares UltraShort Euro fund . Is this move related to global events or something else?

Bond ETFs, which have been the best place to be, account for the largest portion of assets. A quarter of the fund is invested in the iShares Barclays Aggregate Bond Fund , its largest holding. The No. 2 holding is the iShares Barclays 1-3 Year Treasury Fund with 18% of assets.

Emerging-markets bets make up 13% of the IQ Hedge fund's assets. That amount is divided between the iShares MSCI EAFE Emerging Market Fund and the Vanguard Emerging Market ETF .

Investors should consider two caveats before investing in the IQ Hedge fund. First, a manager that uses hedge fund-style strategies should have free reign to take long or short positions in specific countries and industries, but that might be hard to achieve with ETFs that track broad indexes. The fund invests in only a couple of narrowly focused funds, which buy companies in certain regions or sectors.

Second, the fund buys ProShares UltraShort funds to create short exposure, bets that stocks will fall, instead of the traditional method of selling borrowed securities. But there's no guarantee these inverse funds will double the declines of their indexes.

I'm a big fan of what the IQ Hedge ETF tries to do but I suggest giving it a few months to prove itself.

Buzz up!