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The wide sell-off in September confirmed that Wall Street is still in a bear market. However, it also served as a chance for investment firms to prove that their alternative strategies were worthy of attention from investors looking for less volatility. One firm with multiple winners this year is First Trust, which has several funds that have grown in 2022 despite not being the pure reverse index funds or energy-focused products that make up the bulk of the lists. the best performers. Ryan Issakainen, an ETF strategist at the company, described the various offerings as a “toolbox” for advisors and investors looking to diversify their portfolios, and that such markets exemplify the usefulness of alternative strategies. “Despite the fact that the stock markets are starting to perform better again, and they will, such bad conditions remind people why they want to add various risk and asset premiums to their portfolio,” Issakainen said. The funds offer differentiated returns to investors, and they can perform best during the massive sell-offs that hit every sector, such as the September downturn. Merger arbitrage This year, the merger arbitrage strategy proved to be a winner for First Trust and several other investment firms. This is a strategy used by hedge funds, and sometimes even by Warren Buffett, to capture the small upside potential that often exists between the stock being purchased and the posted trade price. The Merger Arbitrage ETF (MARB) from First Trust is actively managed, meaning its portfolio will stand out from others in this space. “They want to invest in the highest quality trades and the most likely that they are actually going to close,” Issakainen said of the fund managers. For example, the fund has no position on Twitter, which is in a legal battle over its deal with Elon Musk. Merger arbitrage certainly involves risk, but it is fundamentally different from broader market risks. At its most basic level, the strategy works as a bet that the deal will be closed at the agreed price, creating little and limited upside potential for the acquiree’s stock. The risk is that if the trade fails, the stock in question could drop significantly, meaning that these trades often have more downside potential than upside. First Trust is also short on trades that managers believe are unlikely to be covered or closed at a lower price. “When the stock market is up 30%, people tend to be less interested in a merger and arbitrage strategy because they tend to be more focused on what we are good at today,” Issakainen said. The fund has raised over $70 million this year, according to FactSet. Another benefit of an actively managed fund during a bear market is that it gives fund managers the freedom to do nothing. Although the fund is designed to be almost fully invested under normal market conditions, Isakainen said it currently has a large cash position. However, if the broader market recovers, the cash pile could be a drag on the portfolio. Another disadvantage of the fund during periods of rising markets is the cost. The fund’s management fee is 1.25%, and First Trust says that interest and margin charges could push the total cost to investors in excess of 2%. Managed Futures Another area where First Trust has been successful this year is managed futures products. The firm has two companies playing in this space: the Absolute Return Alternate Strategy (FAAR) ETF, which uses commodity futures, and the Managed Futures Strategy Fund (FMF), which is a combination of commodity, stock, currency, and interest rate futures. The funds are up about 8% and 12% year-to-date, respectively, according to FactSet, and FMF has raised more than $100 million in inflows. Managed futures strategies give investors a more strategic position than trying to buy broad long funds and inverse funds to get into position. They are also adjusted by professional portfolio managers as market conditions change. Funds are a bit more complex than just buying or selling current futures contracts. One part of the strategy is “to determine from the curve which contract in the long portfolio has the highest probability of achieving the highest return based on a number of different factors,” Isakainen said, describing FAAR. “So once you know what commodity you want to buy, you need to figure out which contract you want to be long. And they do it on the long and short sides of the portfolio,” he said. While these funds provide investors with more subtle risk and professional management, they come at a price. These two funds have expense ratios of over 0.90%, which can be expensive compared to passively managed broad index funds.
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