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ETFs Offer Alternative Investment Options

The increasing number of exchange-traded funds (ETFs) that track commodities, currencies, and other alternative investments are making it easier to diversify your portfolio. Alternative investments include real estate, precious metals, currencies, commodities, private equity funds, and hedge funds, and because the prices of such assets often move independently of stock and bond price fluctuations, alternatives in ETF form may help reduce the volatility of your portfolio. But sorting through the proliferation of alternative ETFs is no easy task.

Before the first commodity-based ETF (the SPDR Gold Trust) was created in 2004, investing in alternative assets tended to be prohibitively expensive and complex. Buying gold, for instance, meant finding a way to store purchased bullion, navigating tricky options or futures markets, or purchasing shares of mining funds or other indirect investments. The SPDR Gold Trust, in contrast, invests directly in gold bullion.

ETFs are similar to mutual funds except they trade like stocks and offer lower costs, greater tax efficiency, and more transparency. Most are designed to follow market indexes passively, but many newer ETFs are actively managed.

Institutional investors and very wealthy individuals have long sought exposure to alternative investments. And though many alternatives lost value during the economic crisis of 2008 and 2009, they have been even more in demand since then because, in the longer-term, their prices have tended to rise when stocks fall.

Two of the most common type of alternative ETFs track currency and commodities markets. Some currency ETFs follow whole baskets of currencies while others are linked to the yen, the euro, or another single currency. While currency ETFs are not considered a long-term investment, they can help you hedge against currency fluctuations arising from geopolitical events. Those worried that the U.S. dollar would decline in the wake of the recent U.S. credit downgrade, for instance, might purchase a basket of other currencies that could potentially gain value against the dollar.

ETF firms have also embraced a full range of commodities exposure, and you can now find ETFs that invest in a single commodity or in several different types of commodities. These ETFs offer a simple, low-cost way to diversify a portfolio and may help protect against rising inflation.

Other ETFs mimic sophisticated hedging strategies. For example, inverse ETFs allow you to profit when the market declines. To better understand the range of these new investment instruments and how they might fit into your portfolio, please give us a call.