ETFs and SMAs: Side By Side

Retail Investing 14 Sep 2006

By: Sydney Leblanc, Financial Advisor Magazine
Published: August 1, 2005

This article for advisors covers ETFs in general.  However, the author makes an interesting observation about the role of ETFs in an SMA for purposes of hedging market risk and essentially creating portable alpha.

“ETFs can also be used as hedging instruments. They can be optioned, margined and shorted. According to ETF pioneer and developer Gary L. Gastineau, a managing member at Summit, N.J.-based ETF Consultants LLC, the short interest in ETFs tells the real story behind their popularity. The interesting thing is the short interest in the typical ETF is about 20% of the shares outstanding, says Gastineau. As of year-end 2004, total ETF assets were reported at $226 billion. If you add the short interest, it’s 20% higher. So in effect, there are a lot more long positions in ETFs than have actually been issued, which means they’re even more popular than they get credit for.

As Washburn mentions above, some ETFs provide a natural hedge through their low correlation to other securities in the portfolio. Tactical asset allocators, however, may find ETFs an easier venue through which to create portable alpha, according to Pruitt. ETFs create a marketable vehicle for an index that can be shorted via an option. It’s certainly more available (than index options).

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