IndexIQ’s ETFs give retail investors exposure to institutional-class asset categories, explains CEO Adam Patti. In part one of MoneyShow.com’s interview, he describes a couple of his indexed ETFs, including one that he puts in the small-cap REIT category.

Kate Stalter: Today I’m speaking with Adam Patti, CEO of IndexIQ. Adam, you have a very interesting company. You have a number of funds that allow investors to participate in multiple segments of the market.

You mention on your Web site that these are alternative ways of getting exposure to areas they might not otherwise. Maybe you can start out today by just saying a little bit about your company’s overall investment philosophy?

Adam Patti: Sure. Very simply, what we’re trying to do is bring institutional-class investment exposures downstream, and allow everybody to gain access to these types of strategies and different segments of the market that typically they may not have had access to before, and in an inexpensive way.

Some parts of the market are just harder to trade, and harder to get access to. And they really represent the hidden gems in the marketplace. So that’s our goal, and we think by doing that, we’re really serving some value for investors. And we try to keep things inexpensive as well.

Kate Stalter: Do you use managers in house? Or is this a system whereby you use sub-advisors? How does that work?

Adam Patti: No, we’re an index shop, so we really are big believers in indexing, and we apply these index-based methodologies in a couple of different ways.

One way we do it is: We apply more sophisticated, institutional-class investment strategies, like hedge funds, and we try to create hedge-like vehicles for retail investors, where they can benefit from the risk-return profile of hedge funds without having to invest in hedge funds.

We all know the issues around hedge funds. They’re very good for diversification, but sometimes the fees and the lockups scare people away. So we create some fully liquid versions of those.

Other things we do are natural resources and small-cap natural resources, large cap. We also do small- and mid-cap country funds, but these aren’t your typical ones that you’d find in the market. These are more unique. They’re more difficult to find access to. Things like small-cap Canada.

All of these, we think, represent a very important part of a potential portfolio. The trick is, of course, getting access to them, and that’s why we’re here.

Kate Stalter: You have a number of funds, and obviously we’re not going to get to all of them today. We can only scratch the surface.

You just mentioned a few that I’d like to talk about, but also I know that you launched one a little less than a year ago. That’s a small-cap REIT ETF. Can you talk about that one, Adam?

Adam Patti: Sure. This is one of favorites. If you’re going to say, “Adam, what are your favorite calls for today,” this would definitely be one of them.

The reason for that is, the real-estate market is very interesting. The problem is that when investors want to play real estate in terms of REITs, they’re always buying the large caps. If you buy a mutual fund or an ETF, or if you’re buying individual securities, everyone is buying the same stocks...Vornado (VNO) and Simon Property Group (SPG) and all of those same names.

Now there’s nothing wrong with that; those are great companies. But the value is in the hidden gems. It’s in those small-cap names that investors are not loading the boat on and that most analysts aren’t covering.

That’s what IQ US Real Estate Small Cap ETF (ROOF) is: the only small-cap REIT ETF in the marketplace. The interesting thing is, not only does it give you access to these small-cap names that the other funds just simply don’t have in their portfolios, but if you look at the portfolio, what you find is that it actually has a lower price-to-earnings ratio than the large-cap funds, has a lower price-to-book ratio, and has twice the dividend yield.

So while the large-cap REIT ETFs have a yield of around 3%, our yield is around 6%. That’s quite a difference. So you’re getting a fund that has undervalued names with higher dividend yields.

And believe it or not, because of the way the fund is structured versus the other large-cap ETFs, your volatility profile is similar. That’s simply because when people want REITs or many of these other segments, again, they’re all buying the same names. They’re pushing the valuations of those names around, up and down based on market sentiment. The small-cap names just simply don’t have those fund flows, so we find the volatility profile similar.

Continued…

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Kate Stalter: I want to come back to another one you were talking about a few minutes ago. You were mentioning some of the hedge-fund ETFs. Can you explain a little bit more how that works? How would you create an index around that particular category?

Adam Patti: Absolutely. This is probably what we’re best known for, and this is something interesting. Our flagship ETF just had its three-year anniversary.

When we launched these ETFs three years ago, people said, “You guys are crazy. You cannot replicate the performance patterns of hedge funds in an easy way.” We said we can, and we have.

And if you look at the track record, they’ve done exactly what we said they would do. Hedge funds are designed to hedge, and what that means is reduce the volatility of your portfolio while retaining outside potential if the market goes up.

Now the interesting thing is that hedge funds...there are 10,000 of them. There’s as many hedge funds out there as mutual funds. And while there’s nothing wrong with that, the reality is that they’re all invested in the same asset classes. It’s a very simple technique to determine what the asset class exposures are of certain hedge-fund styles.

If you could determine the asset-class exposures that the hedge funds are using, it’s even simpler to use liquid proxies as proxies for those asset classes. In other words, what we’ve done is we’ve identified what hedge funds are invested in and we use other ETFs to represent those asset classes, and we package it as an investable product.

So IQ Hedge Multi-Strategy Tracker ETF (QAI) is our multi-strategy ETF, the most popular ETF. What that does is, it provides investors the performance characteristics of a hedge fund of funds.

Again, there’s no lockups. The fees are 75 basis points a year, instead of 2 and 20, which is what hedge funds charge. It’s fully liquid and it’s fully transparent.

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