Non Traditional ETFs Beyond Traditional Investing

Non-traditional ETFs offer a wide range of investment options beyond traditional stocks and bonds. These funds can be used to gain exposure to alternative assets, manage risk, and diversify a portfolio.

One key benefit of non-traditional ETFs is their ability to track unique market segments, such as cryptocurrency or real estate. For example, the Grayscale Bitcoin Trust ETF tracks the price of Bitcoin, allowing investors to gain exposure to this emerging asset class.

Investing in non-traditional ETFs can also provide a way to hedge against market downturns. The ProShares Short S&P 500 ETF, for instance, allows investors to profit from a decline in the S&P 500 index.

Non-traditional ETFs can also be used to gain exposure to specific sectors or themes, such as renewable energy or cybersecurity. The Invesco Solar ETF tracks the price of solar energy companies, providing investors with a way to invest in this growing industry.

Non-traditional ETFs can be a recipe for disaster in volatile markets, as evidenced by the case of SunTrust Investment Services, which was fined $634,000 for unsuitable holdings of these complex investments.

From January 2015 until January 2018, SunTrust failed to establish, maintain, and enforce a supervisory system, including written supervisory procedures.

Non-traditional ETFs are designed to return a multiple of an underlying index or benchmark, the inverse of that benchmark, or both, over only the course of one trading session.

These investments are typically rebalanced daily, which can lead to significant differences in performance compared to their underlying index or benchmark over longer periods.

In the case of SunTrust, 30 customer accounts held ETFs for an average of 1,136 days, resulting in losses of $584,466 in 95 customer accounts.

Non-traditional ETFs held for longer periods can lose value quickly in volatile markets, making them a high-risk investment option.

SunTrust's supervisory failures resulted in unsuitable sales of complex ETFs, which can be tied to an underlying index or its inverse.

The risks of non-traditional ETFs are compounded in volatile markets, where their value can fluctuate rapidly.

Active Management has become a game-changer in the ETF industry. The Securities and Exchange Commission (SEC) approved two new rules in 2019 that fundamentally changed the landscape.

These rules removed many of the expensive regulatory hurdles that made it difficult to launch a new ETF, allowing fund providers to introduce new strategies more quickly. This change opened the floodgates, with active ETF assets reaching $550 billion as of December 2023.

Active ETFs are now more accessible than ever, with fund managers able to shield their methodologies or buy-and-sell decisions for up to a full calendar quarter. This gives rise to what is commonly referred to as active semitransparent ETFs.

The SEC's rule change has led to a significant increase in active ETF assets, with a 55% increase in just one year and a 383% increase since the rule was passed.

Alternative investments can provide a diversification boost to your portfolio, but they often come with higher risks and lower liquidity.

Some alternative investments, like cryptocurrencies, have shown remarkable growth potential, with Bitcoin increasing by over 10,000% in just a few years.

However, they can be highly volatile, with prices fluctuating wildly in a short period.

In contrast, real estate investment trusts (REITs) offer a more stable option, providing a regular income stream and potential long-term capital appreciation.

For example, the VanEck Vectors Mortgage REIT Income ETF (MORT) has a 5.5% dividend yield, making it an attractive option for income-seeking investors.

Another alternative investment option is commodities, which can provide a hedge against inflation and market volatility.

The Invesco DB Commodity Index Tracking Fund (DBC) is a popular choice, offering exposure to a diversified basket of commodities.

Thematic ETFs can help investors align their investments with their interests, but they often have a narrow focus and may not be diversified. Thematic ETFs can be a good option for long-term investors who can overlook short-term swings.

The average expense ratio for a thematic ETF is 0.61%, which is not much higher than the average for all ETFs. However, some thematic ETFs charge upwards of 1%, which can severely erode returns over time.

To research thematic ETFs, you can log in to Schwab's ETF Screener and select the "Fund Name" option to search for relevant themes, such as artificial intelligence or clean energy.

Leveraged and inverse ETFs, on the other hand, aim to deliver multiples of the performance of the underlying index or benchmark. These ETFs deploy various investment strategies, including swaps and futures contracts, to achieve their results.

Non-traditional ETFs, including leveraged and inverse ETFs, are designed for daily use only and can be misused if held for longer-term investment. This is because they can be affected by compounding, particularly in volatile markets.

Here are three key characteristics of non-traditional ETFs:

Active ETFs have taken off, with assets increasing by 383% since 2019.

More than 80 active mutual funds have converted to ETFs to lower costs and attract investors. These conversions tend to happen seamlessly without tax consequences for investors.

Active ETFs often have higher fees than traditional ETFs, which can erode returns.

Active ETFs can have larger bid-ask spreads, which can drag on performance.

Thematic ETFs are a great way to invest in areas that align with your interests and values. 40% of investors surveyed by Trackinsight plan to increase their allocation to thematic investments over the next few years.

The challenge lies in choosing among the many thematic ETFs available, with some charging upwards of 1% in fees. This can severely erode returns over time, making it essential to opt for a lower-fee fund.

A pure-play investment is one that invests only in companies directly involved in the theme, while others may invest in companies that benefit from the theme but aren't necessarily core to its mission.

Some thematic ETFs invest in companies with clean energy ambitions, but still derive most of their profits from oil and gas. Recent regulations require funds to invest at least 80% of their assets in accordance with the investment focus the fund's name suggests.

To research thematic ETFs, you can log in to Schwab's ETF Screener and select Basic, then select Fund Name, and enter a relevant search term, such as artificial intelligence, clean energy, or robotics.

Leveraged and inverse ETFs are a type of non-traditional ETF that can be a bit tricky to understand.

Leveraged ETFs aim to deliver multiples of the performance of the underlying index or benchmark, while inverse ETFs deliver the opposite of the index or benchmark.

These ETFs use various investment strategies, including swaps and futures contracts, to achieve their results.

Non-traditional ETFs, including leveraged and inverse ETFs, are designed to give results on a daily basis only.

Holding shares in leveraged and inverse ETFs for longer-term investment can be dangerous due to the effects of compounding, particularly in volatile markets.

Non-traditional ETFs can be an effective means of trading and shorting within a complex investment strategy when closely monitored by a financial professional.

Both regulatory bodies, FINRA and the SEC, have issued warnings and guidelines for the appropriate use of leveraged and inverse ETFs.

Non-traditional ETFs are meant for daily use only, so holding shares for longer-term investment can be hazardous due to compounding effects.

Investors and financial advisors often misunderstand or misapply the daily reset characteristic of non-traditional ETFs, which can lead to trouble.

Non-traditional ETFs can be a powerful tool for trading and shorting within a complex investment strategy when closely monitored by a financial professional.

However, they're typically not suitable for intermediate or long-term investment, and using them in this way may be considered misconduct and/or unsuitability.

Brokers and financial advisors often misuse non-traditional ETFs due to their complexity, which has led to scrutiny from regulatory bodies like FINRA and the SEC.

Both FINRA and the SEC have issued warnings and guidelines for the proper use of leveraged and inverse ETFs, and you can find more information on their FAQ pages.