09) Exchange-Traded Funds: ETF Alternative Investments

by · October 16, 2010

Alternative investments in ETF is a good way to diversify a portfolio. It is also used for hedging existing positions or gain positions in currencies or commodities.

Currency ETFs

Designed to track movements of currencies in exchange markets, this funds can contain currences such as the Japanese Yen, the Euro, or a mix of other currencies. Investments in a currency ETF are mainly foreign cash deposits or futures contracts. Note that currency ETFs are not recommended for long-term investments, but it is one way to provide protection from exposure to foreign currencies. Funds investing in futures contracts will typically purchase Treasury bonds or other bonds of high-quality.

Examples are:

  • PowerShares DB U.S. Dollar Bullish Fund (UUP)
  • PowerShares DB U.S. Dollar Bullish Fund (UDN)

Commodity ETFs

These are considered hard assets that provide protection against unexpected inflation. There are three types of commodity funds:

  • Those that track individual commidity such as gold or oil.
  • Those that invests in a group of companies that produce a commodity
  • Those that tracks other different commodities

A commodity ETF holds the actual commodity or futures contracts. For ETFs that make use of futures contracts, interest-bearing government bonds are usually bought. The interest takes care of the ETF costs and payment of dividends to the investors.

Examples are:

  • PowerShares DB Commodity Index Tracking ETF (DBC
  • iShares S&P GSCI(R) Commodity-Indexed Trust (GSG)

Inverse ETFs and Leveraged Inverse ETFs

Inverse ETFs were originally designed to move in a direction equally opposite of its benchmarks. It can use short positions of the underylying stocks or futures.  Funds that use futures contracts have excess cash that can be used to buy bonds. This investment will cover the ETF costs and payd dividends to the investors.

Leveraged inverse ETFs are just the same but the opposite movement is double that of a regular inverse ETF.
There are many reasons for buying inverse ETFs. Investors, for example, prefer to use it instead of short-selling the index. Another reason is that it can be used as a hedge.

Inverse funds are bought in tax-deferred accounts. It can be risky in that investors are exposed to unlimited losses.

Examples of inverse ETFs are:

  • ProShares Short QQQ ETF (PSQ)
  • ProShares Short S&P500 ETF (SH)

Examples of leveraged inverse ETFs are:

  • ProShares UltraShort QQQ ETF (QID)
  • ProShares UltraShort S&P 500 ETF (SDS)