Liquid-Alternative
Funds
"Liquid
alternative" mutual funds typically employ hedge-fund-like strategies but
don't come with the same restrictions. There isn't a high investment minimum,
for example, and the funds aren't as difficult to exit as traditional hedge
funds. But skeptics say the
strategies often are too complicated for the average investor to understand,
and many are too new to have a proven track record.
Try instead: If you want some shelter from the risk
of a bad decline in stocks, you could always keep more of your money in cash
instead. It is safer and a lot cheaper.
Nontraded
Real-Estate Investment Trusts
Nontraded real-estate
investment trusts are similar to their public counterparts, which trade like
stocks and allow investors to invest in an array of commercial properties. The investments have
become a concern of the Financial Industry Regulatory Authority, the industry's
self-regulator. Because they are generally illiquid, their performance and
value are difficult to understand and the cost is high, the agency has warned.
Try instead: Publicly traded REITs aren't nearly as risky
and are far more transparent, and they can be a good diversifier in a
portfolio. A mutual fund that holds a basket of commercial real-estate
companies also can provide exposure to the market and is liquid.
Leveraged
and Inverse Exchange-Traded Funds
Leveraged ETFs are designed to
provide investors with a certain percentage return over the movement of a
market over the span of a day. Inverse funds are supposed to move in the
opposite direction of a specific index, to provide protection against declines. Many of these ETFs use
"total return swaps"—a complicated financial agreement that allows a
fund to take on leverage to boost returns. That adds a "counterparty"
risk if the investment bank issuing the swap goes bust, Mr. Nadig says.
Try instead: If you want to make a strong
bet on stocks you can invest in small stocks with a greater potential upside.
Structured Notes
Structured notes are debt
instruments whose returns depend on the price movements of other assets, such
as stocks, currency exchange rates or commodities. A recent survey of 700
financial advisers sponsored by New York-based Exceed Investments found that
complexity and liquidity issues were the main reason why financial advisers
weren't offering them to clients.
Try instead: If you are looking to hedge
against market risk, rebalance your portfolio by increasing exposure to
conventional bonds while decreasing exposure to stocks.
Unconstrained Bond Funds
Fund companies not pushing
liquid-alternative funds are often pitching "unconstrained" bond
funds, also known as "go anywhere" funds. The category has seen
massive inflows as investors worry that traditional bond funds will suffer from
rising interest rates. Theoretically, they are
supposed to make money and limit risk, even in a bond-market downturn. But
those gains are coming from riskier investments. In their push for returns,
many investors don't understand the risks, says Eric Jacobson, an analyst at
Morningstar.
Try instead: If you don't want to take on
additional credit risk but you want to lower your interest-rate risk, a
short-term bond fund is an alternative.
Click here for the full article from The Wall Street Journal.