The Troubling Evolution of Exchange-Traded ‘Products’

The category has morphed in ways that can be extremely risky

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Hedge Fund Alpha ETF

Of course, some exchange-traded products are less nefarious and moreso questionable concepts. The AlphaClone Alternative Alpha ETF (NYSE:ALFA) is among those fitting in here.

ALFA basically tracks long positions by (according to its proprietary methodology) the best-performing hedge fund managers. Which, in and of itself, isn’t a bad idea — as much as we like to crow about when the so-called “smart money” makes head-scratching moves, there’s usually a reason the “smart money” has a lot more money than you or I.

However, the problem is ALFA can only track these acquisitions once they’ve been disclosed, which usually doesn’t happen until months after a position has been initiated. By that point, these hedge fund managers easily could have liquidated their positions, taking profits in anticipation of a drop.

We complain if stock price updates aren’t real-time — so why would you invest with a potentially several-month tape delay?

Frontier Market ETFs

Again, totally legitimate, but again, probably should be avoided by the majority of long-term investors.

“Frontier markets” don’t have a locked definition, but they’re essentially considered to be much more exaggerated “emerging markets.” Because they’re lesser-developed markets, frontier markets have the potential for explosive growth. However, they also involve countries with looser corporate regulations and often extreme political volatility, and many of the companies release much less information than is available from more developed countries’ businesses.

Right now, the Guggenheim Frontier Markets ETF (NYSE:FRN) is pretty much the only widespread game in town, though I wrote back in April that MSCI Inc. (NYSE:MSCI) is creating a spin-off frontier markets index in anticipation of a BlackRock (NYSE:BLK) iShares ETF. Van Ecks also offers more targeted funds for Africa (NYSE:AFK) and the Gulf States (NYSE:MES).

No matter how you get your flavor, though, the sheer risk involved is more on par with gambling than investing. Even with the diversity offered by an ETF, the potential for companies to just implode, or get taken over by the government, etc., is enormous. But once upon a time, India and China were also “frontier markets,” so the allure at least makes sense. If you do decide to tangle with these, it should be with a small part of your investment money that you can afford to lose on a high-growth gamble.

Kyle Woodley is the assistant editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @KyleWoodley.


Article printed from InvestorPlace Media, http://investorplace.com/2012/06/the-troubling-evolution-of-exchange-traded-products/.

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