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The Next Investing Frontier: Liquid Alternative ETFs

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The following content is sponsored by IndexIQ.

Liquid alternative ETFs

The Next Investing Frontier: Liquid Alternative ETFs

Think back to your desires five years ago. As you’ve changed and the world around you has shifted, chances are your desires have also evolved. Similar progressions can be seen in the investing realm.

As investors have become more sophisticated, they have sought securities that provide:

  • Enhanced transparency
  • Lower fees
  • Increased liquidity
  • Diversification

This changing behavior paved the way for emerging investment opportunities, including liquid alternative ETFs. In today’s infographic from IndexIQ, we explain what liquid alternative ETFs are, explore their benefits, and discuss how to use them in a portfolio.

What Are Liquid Alternative ETFs?

In order to define liquid alternative ETFs, it’s easier to break the term into two parts: liquid alternatives and ETFs.

Liquid alternatives are baskets of securities with exposure to alternative strategies. They can be accessed through ETFs, mutual funds, or closed-end funds with daily liquidity. Alternative investments are any asset that is not a stock or bond, such as commodities, real estate, or private equity.

ETFs are baskets of securities that trade on an exchange. They can contain various asset classes including stocks, bonds, commodities, or a mixture.

The benefits of ETFs have been combined with the benefits of liquid alternatives to form a relatively new investment opportunity: liquid alternative ETFs.

Liquid alternative ETFs are the subset of liquid alternatives that trade on an exchange. However, they are not widely used yet. In a recent survey, only 8% of institutional investors currently use them, or have used them in the past. Why aren’t more investors adding them to their portfolios?

Misconceptions about Liquidity

Simply put, there’s limited usage because investors lack understanding of the asset class. In fact, institutional investors view “liquidity during market stress” as the #1 disadvantage of liquid alternative ETFs.

In reality, liquid alternative ETFs are sufficiently liquid in most market conditions. ETFs benefit from two layers of liquidity: the liquidity of the ETF itself, and the liquidity of the underlying securities, known as implied liquidity.

Implied liquidity is accessed through market makers, typically large banks, that facilitate investor fund flows. If there is:

  • Excess demand: Market makers buy the underlying securities, and sell ETF units.
  • Excess supply: Market makers buy ETF units, and sell the underlying securities.

When investors sell ETF units for extended periods of time, market makers have many options at their disposal:

  1. Sell the individual underlying securities, adjusting their pricing to ensure profitability
  2. Hold ETF units and their underlying securities until the selling pressure dies down
  3. Hedge their risk by purchasing derivative instruments or ETFs from other market segments

This range of options ensures liquid alternative ETFs remain liquid, even in volatile markets.

Additional Benefits

Liquid alternative ETFs offer several key benefits for investors looking to branch out from their traditional portfolios.

Lower Fees
The average expense ratio for all 55 U.S. alternative ETFs is just 1.04%. In comparison, hedge funds charge an average management fee of 1.3%—plus a 20-30% performance fee.

Increased Transparency
In contrast to some alternative investments, liquid alternative ETFs provide a high degree of transparency in terms of investment strategy, holdings, reporting, and fees.

Enhanced Diversification
Liquid alternative ETFs have exhibited low correlations with traditional asset classes. Historically, this has provided increased diversification and mitigated risk.

In addition to their many benefits, liquid alternative ETFs are quite versatile in their applications.

Liquid Alternative ETFs in Practice

Institutional investors use this asset class in three main ways.

  1. Core Component: Investors use liquid alternative ETFs strategically as a long-term, diversifying portfolio component.
  2. Transition Management: While cash and money market funds are the most common transition vehicles, alternative ETFs provide efficient market exposure at a reasonable cost.
  3. Fund-of-funds replacement: Many institutional investors use fund-of-funds in their alternative portfolios, but this strategy brings additional fees, a lack of transparency, and potential overdiversification. Liquid alternative ETFs are a compelling replacement.

Whether an investor has short-term or long-term needs, liquid alternative ETFs are a useful tool.

Poised for Growth

With numerous benefits and applications, liquid alternative ETFs are gaining traction. In fact, the market is expected to grow nearly 2.5x by the end of 2020, from $47 billion to $114 billion.

As more institutional investors gain an understanding of this versatile asset class, they will be poised to implement a powerful tool that helps them achieve their clients’ goals.

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RiskGrade: A More Intuitive Way to Calculate Investment Risk

RiskGrade allows for apples-to-apples comparisons of investment risk. For example, GameStop was 2.5 times more risky than global equities.

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Investment Risk

A More Intuitive Way to Calculate Investment Risk

What crucial factors come into play when choosing investments?

At a high level, there’s two sides to the equation: return and risk. While potential profit is important, the volatility or risk of those profits also plays a critical role. In this graphic from MSCI we introduce the RiskGrade™ metric, a more intuitive way of calculating investment risk.

What is RiskGrade™?

One way of measuring investment risk is through volatility. Low risk investments have a smaller range of price movements relative to their historical average, meaning they have less volatility. On the flip side, high risk investments have a larger range of price movements. This means their returns—both gains and losses—can differ substantially from the historical average.

Traditionally, this volatility is measured through standard deviation. However, standard deviation can be difficult for investors to interpret as it has no intuitive reference point. Enter RiskGrade: a score-based measure of volatility that uses a transparent methodology.

  1. Volatility is calculated by measuring the change in investment price over time.
  2. A scaling factor is applied to standardize scores.

In the second step, 100 is equivalent to a 20% standard deviation, which is the average long-term volatility of global equities. Cash would have a RiskGrade of 0, whereas a technology IPO may have a RiskGrade that exceeds 1,000. It should be noted that RiskGrade only captures risk from a market price perspective, and does not consider inflation risk.

Investment Risk Over the Last Decade

To get a better idea of how this works, let’s take a look at the RiskGrade™ of select investments over the period from 2011-2020.

InvestmentRiskGrade
U.S. Corporate Fixed Income25
60/40 Blended Portfolio47
Global Equities71
U.S. Equities71
U.S. REITs84
Emerging Market Equities89
Small Cap Equities93
Long-term Average of Global Equities100
Apple Stock140
GameStop Stock259

Note: RiskGrades are based on gross total returns from December 31 2010 to December 31 2020. See the graphic for the specific indexes used.

U.S. corporate fixed income was the least risky of the group. A 60% global equity / 40% U.S. fixed income portfolio was a third less risky than a 100% global equity portfolio.

Meanwhile, U.S. Real Estate Investment Trusts (REITs) were less risky than emerging market equities and small cap equities.

Of the above examples, GameStop stock had the highest investment risk, with a RiskGrade more than 2.5 times higher than the long-term average for global equities.

Of course, RiskGrades are not static and change over time depending on market conditions. GameStop, which saw heightened volatility as individual investors created a short squeeze, is a strong example of the fluidity of RiskGrades. Based on 5-year intervals, the stock had a RiskGrade of 212 from 2006-2010, and a RiskGrade of 749 from 2016-March 31, 2021—a jump of over 250%.

Monitoring Investment Risk

Investors may want to consider both risk and return when selecting their investments. In comparison to traditional risk metrics, RiskGrade provides a more intuitive way for investors to gauge their risk across individual investments, asset classes, and portfolios.

With clear apples-to-apples comparisons, more investors may be able to easily understand investment risk and adjust their portfolios to suit their personal risk tolerance and goals.

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Race to Net Zero: Carbon Neutral Goals by Country

Which countries have made a net zero pledge, and how strong is it? This map breaks down carbon neutral pledges.

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NPUC Net Zero Global Goals shareable

Race to Net Zero: Carbon Neutral Goals by Country

The time to talk about net zero goals is running out, and the time to put them into action is well underway.

At the U.S. Climate Summit in April 2021, U.S. President Biden pressured countries to either speed up carbon neutral pledges, or commit to them in the first place.

It’s a follow-up to the Paris Agreement, which keeps signatories committed to reaching carbon neutrality in emissions in the second half of the 21st century. But 2050–2100 is a wide timeframe, and climate change is becoming both increasingly present and more dire.

So when are countries committed to reaching net zero carbon emissions, and how serious is their pledge? This infographic from the National Public Utilities Council highlights the world’s carbon neutral pledges.

The Timeline of Carbon Neutral Targets by Country

The first question is how quickly countries are trying to get to net zero.

137 countries have committed to carbon neutrality, as tracked by the Energy and Climate Intelligence Unit and confirmed by pledges to the Carbon Neutrality Coalition and recent policy statements by governments.

But the earlier the pledge, the better, and most of the commitments are centered around 2050.

CountryTarget Year
BhutanAchieved
SurinameAchieved
Uruguay2030
Finland2035
Austria2040
Iceland2040
Germany2045
Sweden2045
Afghanistan2050
Andorra2050
Angola2050
Antigua and Barbuda2050
Argentina2050
Armenia2050
Bahamas2050
Bangladesh2050
Barbados2050
Belgium2050
Belize2050
Benin2050
Brazil2050
Bulgaria2050
Burkina Faso2050
Burundi2050
Cabo Verde2050
Cambodia2050
Canada2050
Central African Republic2050
Chad2050
Chile2050
Colombia2050
Comoros2050
Cook Islands2050
Costa Rica2050
Croatia2050
Cyprus2050
Czechia2050
Democratic Republic of Congo2050
Denmark2050
Djibouti2050
Dominica2050
Dominican Republic2050
Ecuador2050
Eritrea2050
Estonia2050
Ethiopia2050
European Union2050
Fiji2050
France2050
Gambia2050
Greece2050
Grenada2050
Guinea2050
Guinea-Bissau2050
Guyana2050
Haiti2050
Hungary2050
Ireland2050
Italy2050
Jamaica2050
Japan2050
Kiribati2050
Laos2050
Latvia2050
Lebanon2050
Lesotho2050
Liberia2050
Lithuania2050
Luxembourg2050
Madagascar2050
Malawi2050
Maldives2050
Mali2050
Malta2050
Marshall Islands2050
Mauritania2050
Mauritius2050
Mexico2050
Micronesia2050
Monaco2050
Mozambique2050
Myanmar2050
Namibia2050
Nauru2050
Nepal2050
Netherlands2050
New Zealand2050
Nicaragua2050
Niger2050
Niue2050
Norway2050
Pakistan2050
Palau2050
Panama2050
Papua New Guinea2050
Paraguay2050
Peru2050
Portugal2050
Romania2050
Rwanda2050
Saint Kitts and Nevis2050
Saint Lucia2050
Saint Vincent and the Grenadines2050
Samoa2050
Sao Tome and Principe2050
Senegal2050
Seychelles2050
Sierra Leone2050
Slovakia2050
Slovenia2050
Solomon Islands2050
Somalia2050
South Africa2050
South Korea2050
South Sudan2050
Spain2050
Sudan2050
Switzerland2050
Tanzania2050
Timor-Leste2050
Togo2050
Tonga2050
Trinidad and Tobago2050
Tuvalu2050
U.S.2050
Uganda2050
United Kingdom2050
Uzbekistan2050
Vanuatu2050
Vatican City2050
Yemen2050
Zambia2050
China2060
Kazakhstan2060
Ukraine2060
Australia2050 – 2100
Singapore2050 – 2100

As far as early achievers go, Bhutan and Suriname are the only two countries that have achieved carbon neutrality and are actually carbon negative (removing more carbon than they emit). Uruguay’s 2030 target is the earliest to try and match that feat, followed by Europe’s Finland, Austria, Iceland, Germany, and Sweden, who are all targeting 2045 or earlier.

Over 90%, or 124 of the 137 countries tracked above, set a target of 2050 for reaching carbon neutrality. This is largely due to membership in the Carbon Neutrality Coalition, which asks member states to target 2050 for their goal but leaves commitment up to them.

Only five countries have net zero pledges set for after 2050, including Australia and Singapore, which haven’t set a firm target yet. Targeting 2060, in addition to Ukraine and Kazakhstan, is the world’s largest emitter, China. The country’s recent pledge is significant, since China accounts for an estimated 25% of global emissions.

In fact, according to the Climate Action Tracker, 73% of global emissions are currently covered by net zero targets.

How Seriously Are Countries Committing to Carbon Neutrality?

Setting a goal is perhaps the easiest step towards carbon neutrality. But the real challenge is in solidifying that goal and starting to make progress towards it. That’s why it’s important to consider how deeply committed each country’s carbon neutral pledge truly is.

The most rigid commitments are enshrined in law, followed by official government policy, though the latter can change alongside governments. Likewise, proposed legislation shows forward momentum in making pledges a reality, but proposals can take a long time to become enacted (or get derailed).

As it turns out, the vast majority of carbon neutral targets are only under discussion, with no formal action being taken to act on them.

CountryTarget Status
BhutanAchieved
SurinameAchieved
DenmarkLaw
FranceLaw
HungaryLaw
New ZealandLaw
SwedenLaw
United KingdomLaw
AndorraPolicy Document
AustraliaPolicy Document
AustriaPolicy Document
BrazilPolicy Document
ChinaPolicy Document
Costa RicaPolicy Document
FinlandPolicy Document
GermanyPolicy Document
IcelandPolicy Document
IrelandPolicy Document
JapanPolicy Document
KazakhstanPolicy Document
Marshall IslandsPolicy Document
NorwayPolicy Document
PanamaPolicy Document
ParaguayPolicy Document
PortugalPolicy Document
SloveniaPolicy Document
South AfricaPolicy Document
SwitzerlandPolicy Document
U.S.Policy Document
UkrainePolicy Document
UzbekistanPolicy Document
Vatican CityPolicy Document
CanadaProposed Legislation
ChileProposed Legislation
European UnionProposed Legislation
FijiProposed Legislation
South KoreaProposed Legislation
SpainProposed Legislation
AfghanistanUnder Discussion
AngolaUnder Discussion
Antigua and BarbudaUnder Discussion
ArgentinaUnder Discussion
ArmeniaUnder Discussion
BahamasUnder Discussion
BangladeshUnder Discussion
BarbadosUnder Discussion
BelgiumUnder Discussion
BelizeUnder Discussion
BeninUnder Discussion
BulgariaUnder Discussion
Burkina FasoUnder Discussion
BurundiUnder Discussion
Cabo VerdeUnder Discussion
CambodiaUnder Discussion
Central African RepublicUnder Discussion
ChadUnder Discussion
ColombiaUnder Discussion
ComorosUnder Discussion
Cook IslandsUnder Discussion
CroatiaUnder Discussion
CyprusUnder Discussion
CzechiaUnder Discussion
Democratic Republic of CongoUnder Discussion
DjiboutiUnder Discussion
DominicaUnder Discussion
Dominican RepublicUnder Discussion
EcuadorUnder Discussion
EritreaUnder Discussion
EstoniaUnder Discussion
EthiopiaUnder Discussion
GambiaUnder Discussion
GreeceUnder Discussion
GrenadaUnder Discussion
GuineaUnder Discussion
Guinea-BissauUnder Discussion
GuyanaUnder Discussion
HaitiUnder Discussion
ItalyUnder Discussion
JamaicaUnder Discussion
KiribatiUnder Discussion
LaosUnder Discussion
LatviaUnder Discussion
LebanonUnder Discussion
LesothoUnder Discussion
LiberiaUnder Discussion
LithuaniaUnder Discussion
LuxembourgUnder Discussion
MadagascarUnder Discussion
MalawiUnder Discussion
MaldivesUnder Discussion
MaliUnder Discussion
MaltaUnder Discussion
MauritaniaUnder Discussion
MauritiusUnder Discussion
MexicoUnder Discussion
MicronesiaUnder Discussion
MonacoUnder Discussion
MozambiqueUnder Discussion
MyanmarUnder Discussion
NamibiaUnder Discussion
NauruUnder Discussion
NepalUnder Discussion
NetherlandsUnder Discussion
NicaraguaUnder Discussion
NigerUnder Discussion
NiueUnder Discussion
PakistanUnder Discussion
PalauUnder Discussion
Papua New GuineaUnder Discussion
PeruUnder Discussion
RomaniaUnder Discussion
RwandaUnder Discussion
Saint Kitts and NevisUnder Discussion
Saint LuciaUnder Discussion
Saint Vincent and the GrenadinesUnder Discussion
SamoaUnder Discussion
Sao Tome and PrincipeUnder Discussion
SenegalUnder Discussion
SeychellesUnder Discussion
Sierra LeoneUnder Discussion
SingaporeUnder Discussion
SlovakiaUnder Discussion
Solomon IslandsUnder Discussion
SomaliaUnder Discussion
South SudanUnder Discussion
SudanUnder Discussion
TanzaniaUnder Discussion
Timor-LesteUnder Discussion
TogoUnder Discussion
TongaUnder Discussion
Trinidad and TobagoUnder Discussion
TuvaluUnder Discussion
UgandaUnder Discussion
UruguayUnder Discussion
VanuatuUnder Discussion
YemenUnder Discussion
ZambiaUnder Discussion

Uruguay’s 2030 target might be the earliest, but it is not yet set in stone. The earliest commitment actually enshrined in law is Sweden’s 2045 target.

Including Sweden, only six countries have passed their carbon neutral targets into law. They include Denmark, France, Hungary, New Zealand, and the UK.

An additional five countries have proposed legislation in the works, including Canada and South Korea, as well as the entirety of the EU.

Meanwhile, 24 countries have their climate targets set as official policy. They include Brazil, China, Germany and the U.S., some of the world’s largest emitters.

99 of the 137 pledges are only under discussion at this time, or more than 72%. That means that they have no official standing as of yet, and are harder to act on. But as time starts to pass, pressure on countries to act on their carbon neutral pledges is beginning to grow.

The National Public Utilities Council is the go-to resource for all things decarbonization in the utilities industry. Learn more.

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