What Are Alternative ETFs?

It comes as no surprise that four of the top five most searched ETFs in our Trackstar database are market-leading index funds. And this is a good thing. Because The Juice believes that, if you do nothing else with your money, you should invest in the broad market. 

Of course, the SPDR S&P 500 ETF Trust (SPY) covers the S&P 500. The Invesco QQQ Trust (QQQ) takes care of the Nasdaq 100. Stop right there and you’re investing in the biggest companies in the world with a heavy focus on technology stocks. Thrown in the iShares Russell 2000 ETF (IWM) and now you have exposure to the expansive universe of small caps.

Add the iShares 20 plus Year Treasury Bond ETF (TLT) and you have a safe place to park your cash in a U.S. Treasury fund. 

Things get interesting and potentially confusing with the fifth ETF on our Trackstar list — the Direxion Daily Semiconductor Bull 3X Shares (SOXL). We’ll start with it to discuss the broad universe of what The Juice considers alternative ETFs, starting with the ones long-term investors should stay away from and moving to the type we think you should consider. 

We have been discussing non-stock, non-ETF alternative investments a lot in The Juice lately (see the Freshly Squeezed section below). But given the massive selection of ETF products out there these days, we classify certain ETFs alts within what is considered a broad and diverse traditional landscape. 

They’re alts because they give you the chance to execute strategies you likely could not execute on your own. The type of stuff once only available to the big money. However, as we’ll explain, they’re not all suited for your portfolio. 

Like many ETFs of its type, SOXL aims to deliver 300% of the return of the underlying ICE Semiconductor Sector Index that it tracks.

SOXL qualifies as an alternative ETF, however it is not one fit for long-term investors. While it might sound super attractive to generate 3X the return of a hot area of the market, ETFs such as SOXL are designed to be traded over the short-term, typically intraday. 

SOXL is a leveraged ETF that will produce +300% or -300% of its underlying index. You can find ETFs like this for large numbers of indices.

Not to be confused with this type of leveraged ETF is another category of alternative ETFs long-term investors should stay away from. 

Inverse ETFs look to produce two or three times the inverse of an index’s daily performance.

For example, the ProShares UltraPro Short QQQ (SQQQ) aims to produce daily returns that are three times (3x) the inverse (the opposite) of the Nasdaq 100 index (QQQ). 

The ProShares UltraPro QQQ (TQQQ) strives for daily returns that are three times the return of the Nasdaq 100 index. 

As short in SQQQ’s name gives away, it’s a bearish bet, whereas TQQQ reflects bullishness. 

While there might be a place for these instruments in your portfolio or as part of your trading activities, they require advanced knowledge of the overall mechanisms of the market as well as the specifics of leveraged ETFs themselves. 

Now, for alternative ETFs you should consider as complements to a portfolio already set with solid broad market exposure.

Not long ago, The Juice did a series on smart beta ETFs. While we don’t consider all smart beta ETFs alts, some absolutely are. This is a good place to start to develop an understanding. 

Maybe the most straightforward type of smart beta ETF is an equal-weight ETF, which, as the name implies, holds the stocks of whatever index it tracks in equal proportion. Not based on market cap.

When you own, say, SPY or QQQ, you’re going to be significantly overweight stocks such as Apple (AAPL) and Microsoft (MSFT) because the indexes SPY and QQQ track hold stocks based on market capitalization. 

But there’s also the slightly more complicated smart beta ETF style that’s common. One where an ETF still tracks an index, but it’s an index that isn’t based solely, or at all, on market cap. 

While this is definitely an alternative to the market cap approach, we don’t really consider equal-weight ETFs a type of alt ETF. If anything, they’re alt lite. The equal-weight approach doesn’t do anything fancy with an index other than essentially even out the exposure the index, ETFs that track the index and, subsequently, investors have to each stock in the index. 

It gets more interesting when you look at the type of smart beta ETF that tracks an index that uses a relatively complicated process to screen an index for a collection of stocks that meet a certain set of criteria. 

Our sister newsletter, The Spill, covered one last week — the Pacer US Small Cap Cash Cows 100 ETF (CALF). 

Calling it “the small cap strategy you haven’t heard about,” The Spill explained how CALF works:

This ETF solves that problem by screening for companies that don’t just show profits on paper, but generate real cash flow.

Our TrackStar data shows financial pros increasingly looking for alternative strategies as traditional market-cap weighted funds become more concentrated…

CALF takes Warren Buffett’s favorite metric – free cash flow – and applies it to the small-cap universe. 

The fund starts with the S&P SmallCap 600 index, then identifies companies generating significant cash from their operations.

You can read the rest of that Spill at the link above for more, but The Spill referred to the approach CALF uses as an “alternative” strategy. 

Absolutely. And we think CALF qualifies as an alternative ETF because it’s doing something fancy with an index that would be incredibly difficult for everyday investors to accomplish. It’s hard enough to own all of the stocks in a broad market ETF such as SPY or QQQ (obviously), but it’s a whole ‘nother ball game to effectively screen an index based on a metric such as cash flow and come up with a set of names that will not only keep you solvent, but generate impressive returns like CALF has. 

The Bottom Line: Consider this an introduction to the alternative ETF space. Like inning one of an extra inning game with — as impressive as it is — one of the more basic names covered. And, before CALF, a few alt ETFs you’d be best to stay away from. 

Next week in The Juice, as we continue to discuss and dissect alternative investments on the way to 2025 when we’ll help you modernize your portfolio, we’ll dig into some other alternative ETFs we think make sense in the portfolios of long-term investors, both to buy and hold and to speculate with. 

So, forward this email to a friend and tell them to subscribe to The Juice and the Spill for free.

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