Forget Hedge Funds: Buy These ETFs Generating Sizable Alpha

Gone are the days when hedge funds were in high demand. Hedge funds are privately owned companies that invest investors' money into several complicated and exotic financial instruments with a motive to outperform the market, by a wide margin. But in reality, hedge funds underperformed the market in recent times.

An ETFGI source showed that the returns from the S&P 500 have consistently outperformed hedge funds since 2011. These exotic products are expensive enough. As per an article published on Investopedia, “the standard management fees charged by hedge funds, including a common 2% annual management fee and as much as 20% of the profits over a certain hurdle rate” appear costlier than what an ETF charges. Hedge funds’ active management leads to this higher cost (read: Why Are ETFs Beating Hedge Funds on Assets & Returns?).

Generate Alpha Via Vanilla ETFs, Not Hedge funds

As per Fidelity, alpha measures “the difference between a portfolio's actual returns and its expected performance, given its level of risk as measured by beta. A positive Alpha figure indicates the portfolio has performed better than its beta would predict. In contrast, a negative Alpha indicates the portfolio has underperformed, given the expectations established by beta.”

Running the Fidelity screener, we have found out that if an ETF’s alpha falls in the range of 8.44 to 14.95, it is considered high, while a range between 14.95 and above is considered very high. Running that screener, we have observed that some of the top-alpha generating ETFs (as of month-end one year) are plain-vanilla passive ETFs. Below we highlight a few such funds.

SPDR S&P Biotech (MX:XBI) ETF XBI – Alpha 15.33

The underlying index of the fund – the S&P Biotechnology Select Industry Index – characterizes the biotechnology sub-industry portion of the S&P Total Markets Index.

iShares U.S. Aerospace & Defense ETF (HM:ITA) – Alpha 13.79

The fund looks to track the Dow Jones U.S. Industrial Goods & Services Index which is a free-float adjusted market capitalization-weighted index (read: Beyond North Korea, 4 More Reasons to Buy Defense ETFs).

Financial Select Sector SPDR Fund XLF – Alpha 12.95

The fund follows the Financial Select Sector Index. The product is big on banks (44.03%) followed by Capital Markets (20.4%) and Insurance (18.9%) (read: Hot Areas of Last Week and Their ETFs).

iShares MSCI China ETF MCHI – Alpha 12.87

The fund follows the MSCI China Index. This is a free-float adjusted market capitalization weighted index designed to measure the performance of equity securities in the top 85% in market capitalization of Chinese equity markets, as represented by the H-Shares and B-Shares markets.

SPDR Barclays (LON:BARC) Capital Convertible Bond ETF (TO:CWB) – Alpha 11.17

The underlying index – the Bloomberg Barclays U.S. Convertible Bond >$500MM Index – is designed to represent the market of U.S. convertible securities, such as convertible bonds, with outstanding issue sizes greater than $500 million.

Vanguard Global ex-U.S. Real Estate Index Fund ETF VNQI – Alpha 10.77

The underlying index of the fund – the S&P Global ex-U.S. Property Index – is a free-float-adjusted, market-cap-weighted index that measures the equity market performance of international real estate stocks in both developed and emerging markets.

iShares MSCI Taiwan Capped ETF EWT – Alpha 10.6

The underlying index of the fund – the MSCI Taiwan 25/50 Index – consists of stocks traded mainly on the Taiwan Stock Exchange (read: What's Causing the Surge in Taiwan ETFs?).

iShares MSCI EAFE Small-Cap ETF (V:SCZ) – Alpha 10.08

The underlying index of the fund – the MSCI EAFE Small Cap Index – is a subset of the MSCI EAFE Index. The fund is heavy on Japan (29.42%) followed by U.K. (18.19%) and Germany (6.80%) (read: Global Economy on the Mend: 4 Small-Cap ETF Plays).

SPDR Barclays High Yield Bond (MX:JNK) ETF JNK – Alpha 9.5

The fund looks to tarck the Bloomberg Barclays High Yield Very Liquid Index (read: Goldman Sachs (NYSE:GS) Launches Junk Bond ETF).

Vanguard Information Technology ETF (HN:VGT) – Alpha 9.21

The fund looks to track the performance of the MSCI US Investable Market Information Technology 25/50 Index. Internet Software & Services (19.9%), Technology Hardware (16.9%) and Systems Software (14.2%) are the top three segments of the fund.

Want key ETF info delivered straight to your inbox?

Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>