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3 Funds Off the Beaten Path

Diversify with these three niche exchange-traded funds


ETFs for the most part offer low-cost diversification, liquidity and greater transparency than other packaged investment strategies such as mutual funds or units of investment trust. Most ETFs focus on replicating an index and capture profits when the group as a whole performs well. With so many ETFs bringing to market basically the same strategies, diversification in these portfolios can be harder to attain.

Moving away from the mainstream index-based ETFs, a few portfolios bring the liquidity and transparency properties of traditional ETFs and adapt these to strategies that offer little or no correlation to general market fluctuations. Holding assets in such programs can help reduce overall portfolio risk and possibly enhance returns.

One such ETF is the IQ Merger Arbitrage ETF (NYSE:MNA). MNA is a relative newcomer, starting on Nov. 17, 2009, and the fund’s philosophy is to invest in companies that have been the target of a public merger announcement. MNA hedges its positions by taking a short global equity approach. The top 10 holdings and weightings are listed below.

  • Motorola Mobility (NYSE:MMI): 12.37%
  • Invesco Treasury Institutional: 8.43%
  • Southern Union (NYSE:SUG): 6.82%
  • Cepahlon (NASDAQ:CEPH): 6.15%
  • Cash: 5.99%
  • National Semiconductor (NYSE:NSM): 5.68%
  • Varian Semi Equi (NASDAQ:VSEA): 5.27%
  • Family Dollar (NYSE:FDO): 4.89%
  • Autonomy Corp PLC: 4.54%
  • Foster’s Group: 4.39%

The historical returns of MNA, based on price, as of Aug. 31, 2011, are listed below:

  • 1 month: -3.1%
  • 3 months: -3.53%
  • YTD: -1.42%
  • 1 year: -1.89%
  • 3 years: 0.06%

This is an event-driven strategy, and the payoff will occur when the merger arbitrage of the holdings generate profits. Or, simply put, MNA bets on corporate “marriages.” This strategy can be exemplified by its holding in NSM — Texas Instruments (NYSE:TXN) completed its acquisition of National Semiconductor on Sept. 23.

The next ETF is the Guggenheim Spin-Off ETF (NYSE:CSD). CSD plays opposite MNA by taking stock positions in companies that have been spun off within the past 30 months. In other words, CSD bets on corporate “divorces.” This too is an event-driven approach and is subject to when corporate breakups are announced. The top 10 holdings and weightings are listed below.

  • Brookfield Infrastructure (NYSE:BIP): 7.01%
  • Ascent Capital: 6.98%
  • Philip Morris International (NYSE:PM): 6.53%
  • Lorillard (NYSE:LO): 6.48%
  • HSN (NASDAQ:HSNI): 5.84%
  • Altisource Portfolio Solution (NASDAQ:ASPS): 5.8%
  • Total System Services (NYSE:TSS): 5.23%
  • Time Warner (NYSE:TWC): 5.16%
  • Echostar (NASDAQ:SATS): 4.71%
  • Clearwater Paper (NYSE:CLW): 4.67%

As of Aug. 31, 2011, the returns, based on market price, are listed below:

  • 3 months: -10.33%
  • YTD: -2.46
  • 1 year: 17.68%
  • 3 year: 2.66%
  • Since inception: -1.25%

The last program to consider is the JPMorgan Alerian MLP Index ETN (NYSE:AMJ). AMJ is an exchange-traded note that pays a variable quarterly rate of interest generated by the income it collects on its holdings. AMJ holds several energy-based master limited partnerships. The advantage to this is the investor does not receive a K-1 partnership tax form every year. AMJ was created on April 2, 2009, and the note matures on May 24, 2024. The top 10 holdings and weightings are listed below.

  • Enterprise Products Partners LP (NYSE:EPD): 14.04%
  • Kinder Morgan Energy Partners LP (NYSE:KMP): 9.64%
  • Energy Transfer Partners LP (NYSE:ETP): 5.03%
  • Plains All American Pipeline LP (NYSE:PAA): 5%
  • Energy Transfer Equity LP (NYSE:ETE): 4.82%
  • Linn Energy LLC (NASDAQ:LINE): 4.39%
  • Magellan Midstream Partners LP (NYSE:MMP): 4.36%
  • Buckeye Partners LP (NYSE:BPL): 3.59%
  • Kinder Morgan Management LLC (NYSE:KMR): 3.49%
  • Oneok Partners LP (NYSE:OKS): 3.21%

The returns associated with AMJ, as of Aug. 31, 2011, are listed below:

  • 1 month: -2.77%
  • 3 months: -3.36%
  • YTD: 0.15%
  • 1 year: 15.74%

This portfolio of energy-driven limited partnerships has a limited lifespan. AMJ does a good job in selecting a group of energy-based programs, placing them into an ETN that is more tradable than the individual LP units, and offers a variable rate of returns without the tax-reporting implications. Because this program is based on a unique set of holdings, investors seeking diversification should consider adding this ETN to their portfolio.

Jeffrey L. Stouffer is the principal of Mercantile Capital Group, a Herndon, Va.-based introducing broker registered with the CFTC and a member of the National Futures Association. He can be reached at Stouffer does not own any direct or indirect holdings in any of these ETFs.

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