2 ETFs For The Muddle Through Economy (QAI, MNA)

Eric Dutram: Although markets have come back a bit this summer, the economy remains undeniably shaky. Growth in the American economy is coming in below 2%, although the level is still in the positives, giving hope to some investors as we approach the end of the year.

Yet, there are many risks to the American economy as unemployment levels remain stubbornly high, Europe is still in shambles, and emerging market growth rates are coming down for the major economies. Still, on the positive side, the housing market is starting to trend back higher while the Federal Reserve could be poised to embark on another round of easing (see Three Low Beta ETFs for the Uncertain Market).

However, even as the Federal Reserve adds to the QE program, the market and the economy at large will likely be stuck in a narrow range, much as it has been for most of 2012. The first two rounds of QE have had little impact on driving the economy back to solid levels of growth so it is somewhat questionable if another round will have any different results.

These conflicting data points and the lack of government measures to truly stimulate the market, suggest that we are likely to see a ‘muddle through’ economy for the foreseeable future. In other words, markets are likely to oscillate around their current level, but will be unable to breakthrough either to the downside or the upside.  Meanwhile, growth will probably stay in the 1.5%-2.5% range as well; not enough to truly bring back the economy, but certainly not a recession either.

In this type of economic environment, stocks—in aggregate—are likely to offer little in returns, forcing investors to only choose the best securities for purchase. Additionally, the uncertain outlook could increase volatility and make correct selection of securities all that much more important, especially for low risk investors (seeThree ETFs to Prepare for the Fiscal Cliff).

For those who find themselves in this group, a look at some low risk ETFs could be an excellent way to round out a portfolio and its exposure. While correct stock selection is probably necessary in order to generate positive returns in this kind of climate, a look at some lower volatility ETF products could provide some stability as well as being able to offer up at least some equity exposure.

In light of this, we have highlighted a few ETFs below that are decidedly low risk and have generally low levels of correlation to the broad markets. That way, investors can still play stocks but can ensure that when the uncertain market is going one way, at least some of their portfolio is going the other, thus improving diversification levels and making for a potentially better portfolio in this shaky environment:

IQ Hedge Multi-Strategy Tracker ETF (NYSEARCA:QAI)

For investors seeking a low-correlation play on the broad markets, it is hard to go wrong with IndexIQ’s QAI. The fund is one of the more popular ETFs from the upstart ETF issuer, and uses a fund-of-funds methodology to achieve its objective and track the IQ Hedge Multi-Strategy Index.

This benchmark harks back to the ‘traditional’ definition of a hedge fund in that it looks to be a market neutral play that can deliver returns in any economic environment. It does this by seeking to match broad hedge fund strategies including long/short equity, global macro, market neutral, event-driven, and many others (readDoes Your Portfolio Need A Hedge Fund ETF?).

By using this wide combination of strategies in a fund-of-fund way, investors are left with a well diversified product that has an extremely low beta. In fact, according to the fund’s fact sheet, the index beta against the S&P 500 is just 0.29, while the standard deviation for the fund is below 10% (for a one year look).

It also doesn’t hurt that the fund has a heavy weighting in fixed income securities, including two of the top three holdings. Yet, beyond this, the fund does have a smattering of equity ETFs in its basket including ones targeting the EAFE markets, small caps, and the broad U.S. market.

Still, the combination of bonds, currencies, commodities and equities, has kept QAI very stable but in a definite uptrend over the year-to-date period, as it has gained 3.2% since the start of the year. Yet, investors should also note that the product has been extremely stable, trading in a range of just $26.60 to $28.80 over the last 52 weeks.

Unfortunately, investors do have to pay for this broad exposure with somewhat high fees, as total costs come in at 1.06%. While this is high for the ETF world, it is far lower than what more typical hedge funds charge, leaving more for investors in terms of total gains.

IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA)

For another play on the market that takes more of a pure equity approach, investors should consider another fund from IndexIQ, MNA. This product tracks the IQ ARB Merger Arbitrage Index which looks to give investors exposure that is representative of global merger arbitrage activity.

This process is done by investing in global companies for which there has been a public announcement of a takeover by an acquirer. The idea is to buy the company’s shares at a price below the target price and then profit from the spread once the deal goes through. This could be especially true if the deal closes at a price above the initial takeover target price, potentially giving investors solid gains (read Time for a Merger Arbitrage ETF?).

However, it should be noted that no deal is guaranteed and that investors could lose out if the purchase is called off by the acquirer. Still, the strategy has proven to be a low correlated way to play equities and this fund also employs an equity hedge which can help to protect portfolios in down markets.

In fact, according to the fund’s most recent fact sheet, the index of MNA’s beta compared to the S&P 500 is just 0.3, while the standard deviation over the last one year is below 12%. Unfortunately, costs are somewhat high at 76 basis points a year, while volume is rather low—suggesting wide bid ask spreads—which could add to total costs (also see Gold ETFs: Why Bid Ask Spreads Matter).

Nevertheless, MNA has proven to be a very stable performer that moves pretty much independent of the market over the past year. The fund has stayed in a range of just $21.8/share to $26.7/share in the trailing 52 week period and has added about 3.2% in the time frame.

Given these decent numbers and the low volatility inherent in the fund’s style, it could be a great choice for today’s muddle through economy. The product looks to slowly add over time and will likely move independent of broad market woes, making it a great choice for both a flat or an uncertain market situation.

Written By Eric Dutram From Zacks Investment Research  

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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