The inclusion of alternative ETFs in a portfolio provides a risk-adjusted benefit to investors, according to research from Lipper.
Alternative ETFs were defined by Lipper as vehicles that seek exposure to commodities and futures markets or provide a leveraged, short, or hedge fund-like investment strategy.
To determine the impact of alternative ETFs on a portfolio, Lipper's head of Americas research Jeff Tjornehoj created portfolios using mutual funds for aggressive, moderate and conservative investors. Lipper used four ETFs that had a performance history of 60 or more months to represent common alternative ETF choices. The ETFs invested in gold or commodities, or used a short or covered call strategy.
When Lipper looked at total returns when the ETFs were added to the investor portfolios, the firm found that the aggressive investor benefited most. "Adding gold provided the biggest boost to performance, and even an inverse-investment allocation helped this long-equity type. A moderate investor was only somewhat helped by commodities, and the conservative investor was helped only by gold," Lipper found.
But when the result of adding the alternative investments was measured using a modified Sharpe ratio, it became clear that,"in all but one case (conservative investors who included commodities in their portfolio), the inclusion of an alternative ETF had a positive impact on risk-adjusted returns," Lipper said. A Sharpe ratio is used to determine how well the return of an asset compensates the investor for the risk taken.
"In all cases, including gold provided the most return per unit of risk. Curiously, aggressive investors were better off (in terms of risk-adjusted returns) by including a covered-call strategy (often associated with conservative investors) than by investing in an inverse or commodities strategy, which would seem to hold more appeal to that investor type. Along that same line, the conservative investor was better off in Sharpe terms by including an inverse strategy rather than the covered-call option," Lipper said.