12.16.2011
By Terry Flanagan

Trading Woes For All

Trading risks still exist as the oh-so-ever popular exchange trade fund grows in popularity and complexity.

Some proponents of exchange traded funds (ETFs) often brim with pride when advocating for the products’ low cost for investors, transparency, and efficient implementation. As ETFs grow in complexity of strategy and style to mimic their active fund counterparts, so does their risk.

“There is a cost to trade in and out of (ETFs), especially for those that allot for short holding periods. As ETFs become more complex and track thinly trades shares of an underlying security, it can be difficult to get in and out at a low cost,” said Matt Hougan, president of ETF analytics at IndexUniverse.

Hougan cited, during an IndexUniverse webinar: Absolute Return ETFs, a trend that traders of these more complex, “absolute return” ETFs can utilize a limit order to curtail trading risks, and those skilled at “trading below the surface” can find liquidity.

Mastery of trading absolute return ETFs is becoming more paramount for market participants in a time of what some call a “chopping trading range,” described by Victor Sperandeo, chief executive of Alpha Financial Technologies.

Two-thirds of ETFs are “absolute return,” denoting a more “go-anywhere,” flexible nature in the name of chasing uncorrelated market returns. They also represent 1.4 billion of total ETFs outstanding, and there have been a reported 12 absolute return ETF launches thus far in 2011.

“They can be used as tactical tools—leveraging volatility, and diversifying exposure,” Hougan said.
Like absolute return funds, which can be said to often be synonymous with hedge funds, the category is primarily divided into two main areas: global macro and long/short equity.

“Global macro has lots of flavors, and is not vanilla,” Hougan said. “They’re kind of like the Holy Grail of investing because they involve most major asset classes, and are deemed for their uncorrelated nature, and do well when volatility is surging in the market.”

On the other hand, for long/short equity absolute return ETFs, “the alpha is the piece on top,” said Hougan.

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