Alternatives ETFs: Everything You Need to Know

Learn how alternatives ETFs work, and if they’re a fit for your portfolio.

kent
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Research Lead
Reviewed by: Lisa Barr
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Edited by: Lisa Barr

Alternative ETFs can be a smart addition to a diversified portfolio, especially when you understand how they work and confirm that their benefits and risks align with your goals and risk tolerance. 

In this guide, learn the basics of alternative investments, their benefits and risks, and the types of ETFs that invest in them. 

What Are Alternatives ETFs? 

Alternatives ETFs, commonly referred to as alternative ETFs, are exchange-traded funds that provide exposure to alternative asset classes or investment strategies. Traditional ETFs typically track mainstream asset classes like stocks, bonds or commodities, whereas alternative ETFs offer access to nontraditional or niche investment opportunities. 

It's important to note that while alternative ETFs offer access to unique investment opportunities, they often involve higher risks, complexities and potential for volatility compared to traditional ETFs. Investors should thoroughly research these ETFs, understand their underlying strategies, and consider their suitability in line with their investment objectives and risk tolerance. 

What Are the Types of Alternative ETFs? 

Alternative ETFs aim to deliver returns that are not closely correlated with traditional market indexes, providing investors with diversification benefits and potential for enhanced risk-adjusted returns. There are many different alternative types of ETFs, including alternative energy ETFs, alternative income strategies and volatility-based strategies. 

The main types of alternative ETFs include: 

  • Hedge fund strategies: Some alternative ETFs replicate the investment strategies employed by hedge funds, such as long/short equity, market-neutral or event-driven strategies. These ETFs attempt to deliver hedge-fundlike returns at a lower cost and with greater liquidity. 
  • Factor ETFs: Factor ETFs work by using a rules-based approach to selecting and weighting their investments. This means that the ETF will have a set of specific criteria that it uses to identify companies that meet its desired factor profile. Once these companies are identified, the ETF will then weight them based on their importance to the desired factor.
  • Multi-asset strategies: These alternative ETFs may invest in multiple assets, such as stocks, bonds, commodities and real estate investment trusts (REITs) to achieve their performance strategies.
  • Alternative income strategies: These ETFs pursue strategies that generate income beyond traditional fixed income investments. Examples include funds focusing on high yield bonds, dividend-paying stocks, preferred securities or mortgage-backed securities. 
  • Volatility and risk management: Certain alternative ETFs use volatility-based strategies to manage risk or exploit market volatility. They may involve options contracts or other derivatives to hedge or profit from market fluctuations.
  • Commodities and managed futures: Alternative ETFs can focus on commodity-based investments, such as precious metals, energy, agriculture or broader commodity indexes. Additionally, they may provide exposure to managed futures strategies, which involve trading futures contracts on commodities, currencies or other financial instruments. 
  • Antiques and collectibles: These ETFs invest in companies involved in the production, distribution or sale of antiques and collectibles, or they may directly hold physical assets in their portfolios. They may include a wide range of collectible categories, such as rare coins, stamps, fine art, vintage cars, wine, sports memorabilia and other valuable items. 

What Are the Top Alternative ETFs? 

Determining the "top" alternative ETFs can depend on various factors, including performance and assets under management. It's essential to conduct thorough research and consider your specific investment needs before making any investment decisions.

Here are some popular alternative ETFs, as measured by AUM, through May 16, 2023: 

  • iShares MSCI USA Quality Factor ETF (QUAL): This ETF invests in U.S. large and midcap stocks with strong profitability, stability and earnings quality. It has over $28 billion in AUM and an expense ratio of 0.15%.
  • Pacer U.S. Cash Flows Cows 100 ETF (COWZ): This ETF provides broad-based U.S. large cap equity exposure, with the investment thesis that higher free cash flow is a mark of stability. COWZ has over $12 billion in AUM and an expense ratio of 0.49%.
  • iShares MSCI USA Momentum Factor ETF (MTUM): This ETF invests in U.S. large and midcap stocks with strong momentum, meaning they have exhibited strong recent performance. It has approximately $10 billion in AUM and an expense ratio of 0.15%. 
  • iShares Global Clean Energy ETF (ICLN): ICLN invests in global companies involved in renewable energy, clean technology and environmental solutions. It offers exposure to the clean energy sector, including solar, wind and other renewable energy sources. ICLN's AUM is approximately $5 billion and its expense ratio is 0.40%.
  • iMGP DBi Managed Futures Strategy ETF (DBMF): This ETF aims to emulate the performance of a group of commodity trading advisor hedge funds. The fund’s model allocates weights to derivatives selected by the hedge funds’ active managers. DBMF has $733.66 million in AUM and an expense ratio of 0.85%.
  • First Trust Long/Short Equity ETF (FTLS): This ETF takes both long and short positions in U.S.-listed equity with U.S. and foreign exposure. This actively managed fund will typically be 90-100% long and 0-50% short. FTLS has $634.40 million and an expense ratio of 1.36%. 

Does Vanguard Offer an Alternative ETF? 

Vanguard is popular with investors, and many wonder if it offers ETFs with alternative strategies. Its largest offering of this kind is a mutual fund, the Vanguard Alternative Strategies Fund (VASFX). However, Vanguard offers several alternative ETFs, such as the Vanguard U.S. Value Factor ETF (VFVA), Vanguard U.S. Momentum Factor ETF (VFMO) and Vanguard U.S. Minimum Volatility ETF (VFMV)

What Are the Benefits and Risks of Investing in Alternative ETFs?  

Investing in alternative ETFs can offer various benefits and risks. It's important to carefully evaluate these factors before making investment decisions. Here are the key benefits and risks associated with investing in alternative ETFs: 

Benefits of Alternative ETFs  

  • Diversification: Alternative ETFs can provide diversification benefits by offering exposure to asset classes that may have low or negative correlations with traditional investments like stocks and bonds. This diversification can help reduce overall portfolio risk. 
  • Access to unique opportunities: Alternative ETFs allow investors to access markets and strategies that were traditionally available only to institutional or high net worth investors. They provide opportunities to invest in niche sectors, alternative asset classes or specialized strategies. 
  • Liquidity: ETFs trade on stock exchanges, providing investors with relatively high liquidity compared to direct investments in alternative assets. Investors can buy and sell shares of ETFs throughout the trading day at market prices. 
  • Cost efficiency: Alternative ETFs generally have lower expense ratios compared to actively managed alternative investment vehicles like hedge funds or private equity funds. This cost efficiency can result in improved net returns for investors. 
  • Transparency: ETFs typically disclose their holdings on a daily basis, allowing investors to have visibility into the underlying assets held by the funds. This transparency helps investors understand the composition and risks of their investment. 

Risks of Alternative ETFs 

  • Volatility: Some alternative investments can be subject to higher levels of volatility and price fluctuations compared to traditional asset classes. Investments in commodities, real estate or niche sectors may be more sensitive to market conditions and macroeconomic factors.
  • Market risk: Despite their diversification qualities, alternative ETFs are still exposed to general market risks, such as economic downturns, geopolitical events or changes in investor sentiment. These factors can influence the performance of the underlying assets and the ETFs themselves. 
  • Complexity: Alternative ETFs may employ complex investment strategies, derivatives or involve exposure to less liquid or illiquid assets. Understanding these strategies and associated risks may require a higher level of investment knowledge and due diligence. 
  • Lack of track record: Some alternative strategies or asset classes may have limited historical data or track records, making it challenging to assess their performance and risk characteristics. This lack of track record can introduce additional uncertainty. 

Bottom Line 

Alternative ETFs can provide investors with unique investment opportunities and may help to diversify a portfolio. As with any other investment security, it's important to thoroughly research and understand the specific alternative ETFs under consideration, including their investment objectives, strategies, historical performance, expenses and associated risks.

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.