As the deadline for raising the U.S. debt ceiling nears, anxious investors are wondering whether they should be worried about a market crash and, if so, how they can protect their portfolios.

It’s a tough call. If you're betting against a debt ceiling deal and the expecting an ensuing market crash and decide to cash out, you might miss a huge opportunity if the squabbling politicians manage to strike a deal.

On the other hand, if you sit tight hoping for the best and there is no deal, the market could crash and take your portfolio with it.

Adam Patti, CEO at IndexIQ, a small fund manager out of Rye Brook, N.Y., thinks he has another answer -- one that he said gives investors downside protection, but also allows them to benefit if things go the other way and Washington strikes a deal by the Aug. 2 deadline.

His answer: exchange-traded funds (ETFs) that mimic what hedge funds do.

“We have ETFs that follow a factor-based approach, identifying and buying the asset classes that certain hedge funds are holding,” Patti said. “And we have hedge funds that actually buy shares of the hedge funds themselves.”

Take the company’s IndexIQ IQ ARB Merger Arbitrage ETF (MNA). It’s invested in ETFs like the Vanguard Extended Market (VXF), the iShares MSCI Russia Capped Index (SRUS) and the Powershares S&P Small Cap Energy Portfolio (PSCE), which track activities in the global M&A marketplace.

Or take the IQ Hedge Macro Tracker (MCRO), which invests in a group of primarily Asian and emerging market ETFs in an effort to “replicate the risk-adjusted return characteristics” of hedge funds in the “long/short equity, macro, market neutral, event-driven, fixed-income arbitrage and emerging market” areas.

Patti says IndexIQ also offers a mutual fund, the IQ Alpha Hedge Strategy Fund (IQHIX) which is -- unlike the firms ETF offerings -- 25% internally leveraged. This fund invests in ETFs, and top 10 holdings include the iShares iBoxx $ Invest Grade Corporate Bond Fund (LQD), the Vanguard Total Bond Market ETF (BND), the SPDR S&P 500 (APY), the PowerShares DB Gold ETF (DGL), and the iShares Silver Trust Fund (SLV). 

Patti argues that in order to hedge their portfolios, investors should have a minimum of 10% of assets invested in products like IndexIQ’s ETFs, or in other hedged investments, and he said these days being 30% hedged is better still.

Referring to leveraged inverse products with names such as UltraX or Double Long, he said, “These can be good tools for hedging a portfolio, but they should only be used by people who know what they are getting, and who know how to use them. You need to re-balance daily or you can get killed.”

In contrast, he said the IndexIQ products are meant to be “buy and hold”  in the same way that a large institution or a high net worth individual investor might invest in a hedge fund.





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