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By Paul Justice, CFA | 06-16-2011 01:13 PM

Gaining Access to Alternatives With ETFs

A number of new ETF products are making it easier for individuals to obtain access to traditional hedge fund strategies without paying hedge fund fees.

Paul Justice: Hi there. I am Paul Justice with Morningstar. Today we're going to talk about the growth of the alternative investment world and brining some traditional hedge fund strategies and other complex institutional type of strategies into the 40 Act mutual fund world and exchange traded funds. Today I'm joined by Jonathon Steinberg from WisdomTree. Thank you for joining me.

Jonathan Steinberg: Thank you.

Justice: So this is probably the next area of growth that's available for ETFs. It's to reach into these kind of hedge fund strategies and bring them to the ETF world, perhaps lowering their fees and bringing greater transparency. Could you talk a little bit about what WisdomTree is doing to address these areas?

Steinberg: So earlier this year we launched the first 40 Act managed futures ETF strategy fund [WisdomTree Managed Futures Strategy WDTI]. So we're long-short commodity, currency, and interest-rate futures, with a monthly rebalance, and we go either long or short. So now we're going into not a mutual fund world per se, but a traditional hedge fund strategy. There's about $300 billion in 2 and 20 CTA [Commodity Trading Advisors] commodity pool-operated assets. And so this is how we, the ETF industry, grow the pie by expanding the asset classes in which we compete. And so you're getting this noncorrelated asset that can diversify your portfolio, but you're doing it at price points that you never had before with greater liquidity. And when you're going up against hedge funds where it's really much less liquid...

Justice: Like lockup?

Steinberg: With lockups and in times that are stressed, you might actually be gated, right. There is no way that the ETF can stop you from liquidating or redeeming if you want. So it has great benefits, and I think this is one example of that growing trend of these institutional-quality strategies coming out in the ETF format that's knocking down barriers.

Justice: So, to me it's really kind of this coincidental growth of the index industry and the ETF industry to really bring these strategies together and put them out to people.

Steinberg: I think for sure. If you go back a decade, if you wanted your gold exposure, you actually had to buy bullion, right? You could also buy the gold-mining stocks, but if you wanted the physical gold, you actually had to go into the bullion market. Most intermediaries weren't going to be willing to that. Then you see State Street launch GLD [SPDR Gold Shares GLD], and now gold becomes an asset class that's suitable for anyone, if they wanted. Again, that's the beauty of the ETF industry.

Another example of something that WisdomTree has done, we recently during the last year and a half launched a couple of equity funds. We've hedged out the yen [WisdomTree Japan Hedged Equity DXJ]. And it could be a specialty equity, but in my head it really sits in the alternatives bucket. So for us the big success has been Japanese equities where we've hedged out the yen. It's been a good asset gatherer, and I think there's a strong investment thesis underlying that product.

You're now seeing Deutsche Bank coming out with some similar types of equities where they've hedged out or will be hedging out their currency exposures [DBX MSCI Brazil Hedged Equity DBBR, DBX MSCI Emerging Markets Hedged Equity DBEM, DBX MSCI EAFE Hedged Equity DBEF, DBX MSCI Japan Hedged Equity DBJP, DBX MSCI Canada Hedged Equity DBCN]. I think when you talk about the active exemption that the industry has gotten, for the people who aren't in the ETF industry day-to-day, unlike you and me, they might not fully understand what it means. It means no index, so anything that doesn't have an index is active. So it really for the sponsor means flexibility. You will see a wave of innovation that has really just started during the last maybe 18 months, and it will accelerate in the coming years.

Justice: Yeah, and it's an exemption that's very difficult for many firms to acquire and has gotten more difficult over the years.

Steinberg: Active is more difficult than the traditional third-party index licensing, but where it gets much more complicated is the ability to use derivative instruments within your active exemption, something that WisdomTree does have that we've been very successful in creating products that take advantage of that unique exemption.

Justice: It's certainly some products that I can see some demand for but they are certainly not for everyone. For many people these will the corners of the portfolio or someone with a very nuanced investment thesis.

Steinberg: There is no question about it. Our currency funds [WisdomTree Dreyfus Euro EU, WisdomTree Dreyfus Japanese Yen JYF, WisdomTree Dreyfus Brazilian Real BZF, WisdomTree Dreyfus Chinese Yuan CYB, WisdomTree Dreyfus Indian Rupee ICN, WisdomTree Dreyfus New Zealand Dollar BNZ, WisdomTree Dreyfus South African Rand SZR, WisdomTree Dreyfus Emerging Currency CEW, WisdomTree Dreyfus Commodity Currency CCX] are delivering beta and using the active exemption and non-deliverable forwards in the emerging-markets space where you really don't have access to the underlying money market instruments. So, just as an example, the currencies themselves is an asset class that most intermediaries don't have familiarity with, and there is an educational process to it. But in certain market cycles, it serves a benefit.

If you are interested in diversifying your dollar exposure, these products may serve you well. So, choice is always good, and the beautiful thing about an ETF is there is no commitment from the investor. If you like it you buy it. It's all meritocracy. There are no loads. There are no sales fees or charges. And if you don't like it, you sell it. You don't need to romanticize the ETF. It's just a tool, an investing tool, that may at certain times fit into your investment thesis.

Justice: Great. Well, I appreciate you sharing your insights with us today, and we look forward to having you back.

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