Exchange Traded Funds

ETFs render many alternative asset classes investible to those investors who might otherwise find it difficult or impractical to participate.

Substantial sums of money are often required in order to participate directly in asset classes like property, infrastructure and private equity, it is difficult to achieve suitable diversification, management costs can be high, the administration can be complicated and, particularly important ,they are illiquid. Using ETFs to invest in alternative asset classes solves these problems. They are simple listed investments that track the indices of the listed companies operating in these fields.

On the other hand, it needs to be kept in mind that investing in asset classes like these through ETFs that track the relevant indices of listed companies, will result in more volatility in capital value than investing in physical property, physical infrastructure and private equity investments or funds of physical investments in these fields. This risks undermining the so-called  “low correlation” argument for alternative investment.

One of the main arguments that is advanced for alternative investments is their low correlation with more mainstream investments. In other words, many alternative investments might hold their value better during periods of falling equity markets, albeit perhaps lagging rising markets. Listed companies and their associated ETFs in fields like property, infrastructure and private equity cannot be depended upon to display this low correlation in the short-term. Although their medium and long-term performance will be driven by the performance of their underlying asset class, the fact that they are listed and their prices can change by the minute means that they will inevitably be caught up in major stock market moves.

However, the correlation argument for alternative investment can be over-stated. Many alternative investments are only valued periodically. For example, physical property or a private equity investment may be carried in a portfolio at a fixed value between valuation dates which will lend an air of stability during periods of volatile stock markets. However, if the economic environment which is causing that stock market volatility also means that the property or private equity investment is re-valued up or down by 15% at a stroke when the next periodic valuation date comes around, that stability and low correlation will have been to some extent illusory.

Low correlation that is structural in character rather than temporary is difficult to find. Ultimately, the performance of all “real” asset classes will tend to be driven by a common set of factors of which economic growth is often the most important. Ultimately, the performance of all “monetary” asset classes will tend to be driven by a common set of factors of which the level of interest rates is often the most important.