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ETF Specialist

A Hedge Fund for Cheap

New commodity ETN could provide safe haven in the crisis.

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Markets like the present, in which equities, bonds, other currencies, and even commodities seem to fall further each day, show us the value of true diversifiers--assets or strategies that somehow elude the investing truism that "in a crisis, only the correlations go up." Hedge funds originally arose to perform precisely this role by investing in new asset classes and new financial strategies that would remain unscathed by a market fall, but their hefty fees and lack of disclosure made it difficult to tell what they were actually investing in and a very expensive gamble to see if their strategy would pan out. Fortunately, some clever ETF managers and index companies were also reading the academic papers that uncovered potential sources of uncorrelated returns, and the fruits of their labor are now available to adventurous individual investors willing to find a place for bargain-priced alternative investments in their portfolios.

One of the most exciting newer funds we have seen in this area is  ELEMENTS S&P CTI ETN (LSC), a new exchange-traded fund that follows Standard & Poor's little-known long-short Commodity Trends Indicator Index. This long-short index makes monthly momentum trades on each of six commodity sectors (energy, precious metals, industrial metals, grains, livestock, and more exotic agricultural goods) based upon whether the sector index's current price is above or below a weighted average of the previous seven months' prices. The weighted average skews  heavily toward the trailing three months, making this fund sensitive to medium-term movements in commodity prices. Testing this strategy over the past 20 years, it has shown slightly higher returns than traditional long-only commodity indexes with substantially lower volatility. Best of all, it has even held up extremely well over the past few months! As commodity prices began to fall in July and August, the fund slowly switched out of its long positions. By October, it was almost entirely short and able to return 20% in the month as oil, gas, gold, and agricultural commodities collapsed.

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Bradley Kay does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.