Alternative ETFs: Types, Uses, and Portfolio Risks

Exchange-traded fund launches have exploded in recent years. In such a crowded marketplace, alternative ETFs aim to offer something different than mainstream assets. The category has attracted $11.1 billion in inflows in 2026 through August, already topping the previous flows record.

But alternative strategies aren't always right for investors. What advantages are new, and what could be accomplished with traditional stocks and bonds?

With open client discussions, advisors can prove that they’re on top of market developments. The Liquid Alternatives Landscape explores how alternative investments are reshaping portfolios and what this means for investors and advisors. 

Let’s get into the data.

Alternative ETFs aim to expand, diversify, or eliminate the dominant risk factors of traditional stocks or bonds.

Many alternative strategies are restricted to hedge funds, reserved for accredited, high-net-worth investors. Alternative ETF products offer a liquid way to tap into these strategies.

Morningstar organizes liquid alternatives based on their role in a portfolio:

• Adjusting, not eliminating, risk. Modifiers correlate with traditional risk factors but use derivatives or hedging to reshape portfolio characteristics. They typically maintain net long exposure while aiming to reduce volatility or enhance risk-adjusted returns.
• Seeking uncorrelated returns. Diversifiers look beyond traditional stocks and bonds, tapping into volatility, interest rate differentials, or market-neutral value.
• Capital preservation in shifting markets. Opportunists focus on absolute returns, moving between long and short exposures. They often perform best during volatile or disruptive environments.

Event-driven strategies aim to profit when security prices change in response to corporate actions, such as mergers, takeovers, and restructures. For example, a merger arbitrage fund often tries to exploit doubts that an announced deal might close by buying the shares of the acquisition target and selling the acquirer’s stock short. Activist-shareholder and distressed-investment strategies also fall into this category.

These portfolios typically focus on equity securities but can invest across the capital structure. 

So far, events-driven ETFs are a small group. Morningstar's database covers seven ETFs with $851 million in net assets as of August 2026.

Macro-trading ETFs rely on macroeconomic indicators and fundamental data to make directional bets on the global economy. These strategies can be long or short across all asset classes depending on where they see the best opportunities.

Return drivers can include interest rate cycles, inflation, or central bank policy. These strategies may invest across global equities, bonds, currencies, and commodities. They also use a lot of leverage and derivatives. Like systematic trend funds, they may help preserve capital in market drawdowns.

The Morningstar database covers five macro-trading ETF share classes with net assets of $186 million as of August 2026. All launched since 2025, and all are active ETFs.

Systematic trend strategies rely on trend-following price momentum signals to capture market trends. They make long and short bets across equity, fixed income, currency, and commodity markets.

With a focus on absolute returns, these funds aim for positive returns in all markets and don’t share the same risk exposures as stocks and bonds. This results in low or negative correlation with the broad equity market, making it a compelling diversifier for stock/bond portfolios.

Today’s category offerings are largely managed-futures ETFs. These funds generate returns by trading futures contracts, often including several contracts of up to hundreds of futures globally. They tap a straightforward formula: Buy what’s up, sell what’s down.

The best explanation for why trend-following works is human inefficiencies. Investors react to new information too slowly.

Managed-futures performance comes in fits and starts. Stretches of underperformance can make it difficult to stick with managed futures.

The Morningstar database includes 17 ETFs with $8 billion in net assets at the end of August 2026.

Digital asset ETFs use both active and passive management approaches to access digital assets through physical or derivative exposures. They can incorporate long-only investments and other hedging techniques. These funds invest most of their assets into:

• Decentralized finance, or DeFi, assets
• Stable coins
• Currency assets
• Smart contracts platforms
• Exchange assets
• Privacy assets
• Yield farming
• Nonfungible tokens, or NFTs

The year 2024 marked the first time funds could invest directly in crypto instead of tracking the price via futures. Despite the boom in private-market interest, crypto remained the most widely held alternative investment by retail investors in a recent Morningstar survey.

While popular, digital assets come with volatility and unproven diversification benefits that may catch clients off-guard in a downturn. Risk scoring tools can reveal the volatility risk across portfolio holdings.

Ass of August 2026, 156 digital asset ETFs hold $122.5 billion in net assets.

Relative value arbitrage ETFs use an absolute return strategy that tries to exploit discrepancies in value between two related securities by wagering that difference will narrow.

These funds usually have little or no market sensitivity. Relative value arbitrage ETFs invest across asset classes and use one or a combination of debt, equity, and convertible arbitrage strategies, among others. They can use significant leverage and typically seek to profit from the convergence of values between securities.

Morningstar's database includes only three relative value arbitrage ETFs, the largest of which is the Calamos Tax-Aware Collateral ETF CBOX.

Multistrategy portfolios provide exposure to two or more of Morningstar’s alternative investment strategies. At a minimum, alternatives must comprise greater than 30% of the strategy’s gross exposure.

These funds typically aim to have low to modest sensitivity to traditional market indexes. However, that may not be the case for strategies with lower alternatives allocations.

Morningstar covers 12 multistrategy ETFs in the United States, with $939 million in net assets as of August 2026.

• Complexity can introduce undesired risk. Alternative ETFs are still unfamiliar to many investors. In one survey, half of respondents couldn’t define alternative asset classes beyond crypto and commodities. This merits caution. Investors might have a hard time understanding their complex structure and need more education to manage expectations.
• Asset-class correlations can shift in volatile markets. The correlation dynamics between alternatives and traditional investments can shift during market stress, potentially reducing diversification benefits precisely when they're most needed. This behavior requires careful monitoring.
• Despite the ETF structure, liquidity can vary. While liquid alternatives offer daily redemption capabilities, underlying strategies may invest in alternatives such as private markets or illiquid securities that could face constraints during stressed conditions. That could be risky for income investors seeking a stable source of cash flow.

Alternatives aren’t right for everyone. When advisors talk to clients about liquid alts, they need to provide clear explanations of asset classes. Generative AI tools can help rephrase concepts and make them digestible to investors.

Compare alts against other investments that could suit clients' risk tolerance and goals to help investors find the best alternative products. These discussions can help manage client expectations and lead to stronger relationships.

Success with alternatives depends on integrating strategies thoughtfully and setting realistic expectations. Alternative strategies often behave differently from traditional assets; patience is essential.

Direct Advisory Suite helps advisors cut through the complexity of liquid alternatives with the tools to evaluate, compare, and integrate these strategies into client portfolios with confidence.