When asked his opinion about the stock market, J.P. Morgan, the influential American financier and banker, allegedly quipped, “The market will fluctuate."

This succinct statement serves as a reminder that market gyrations are a natural part of investing. Moreover, the stock market is inherently volatile and unpredictable. For that reason, commonsense tactics that reduce risk and the possibility of severe setbacks merit attention.

Alternative investments can offer several benefits to this end, since they’re different from traditional investments like stocks and bonds.

The idea of using alts in portfolios is proven. David Swensen, the late manager of Yale’s endowment, pioneered the "Yale Model," which made regular use of alternative investments like private equity, real assets and venture capital. His approach delivered legendary results that helped the endowment significantly outperform traditional endowment models.  

In the exchange-traded fund market, the alts products can run the gamut—focusing on things as disparate as commodities strategies, managed futures, long/short equity and other themes. Since these themes can vary so much (in both approach and asset coverage), a multi-fund solution is often better than a one-trick-pony application.

“When I build alts portfolios, I do it with four or five funds,” said Shana Sissel, the founder of Banríon Capital Management, an alternatives platform. “You should build it like building equity and fixed-income exposure. You shouldn’t just use one fund.”

By using a strategic combination of several alternative funds, the potential benefits are that the client owns funds that aren’t correlated to each other or broader financial markets.

Let’s analyze a few ETFs that play in the alternatives class.

AGF U.S. Market Neutral Anti-Beta Fund (BTAL)
This fund fights volatility with negative beta exposure to U.S. stocks, and it could act as a diversifier for clients with overweight positions in equities.

It works by simultaneously taking long positions in low-beta (low-volatility) U.S. equities while taking short positions in high-beta U.S. equities. By seeking exposure in the performance spread between low- and high-volatility stocks, the fund tries to minimize portfolio volatility and cut the impact of drawdowns.

The AGF fund could also be an effective alternative to Treasurys and low-volatility funds for those clients whose goal is to diffuse their overall portfolio risk.

Toews Agility Shares Managed Risk ETF (MRSK)
This fund is designed to participate in bull markets while maintaining a managed amount of risk. While the fund avoids stock picking, it’s always long on equities and hedged against downturns.


Hedges are accomplished by purchasing at- or near-the-money two-year equity index put options, rolled annually. To neutralize hedging costs, the Toews fund sells out-of-the money equity index calls and put options spreads.

The fund is actively managed, which provides some level of comfort during edgy markets. And its net expense ratio of 0.97% is reasonable for what it provides.

Direxion Auspice Broad Commodity Strategy ETF (COM)
Most traditional commodity funds can only benefit if commodity prices rise. However, these long-only commodity strategies struggle with performance because commodity returns are usually cyclical and sporadic.

This Direxion fund takes a different approach because it has the flexibility to be long or flat on a basket of 12 different commodities. If the trend for a certain commodity is negative, the ETF can move the position to cash. Portfolio changes are dynamic and can even occur during the month.

Instead of employing a full-blown active strategy, the Direxion fund is linked to the Auspice Broad Commodity Index. Another benefit of the fund is that it does not generate a K-1 tax report, which makes the tax reporting simpler.

Advantages
The key advantages of alternatives, again, are their low correlation with traditional asset classes, as well as their potential for capital preservation and income generation.

Alts that come in ETF wrappers, meanwhile, offer clients access to sophisticated strategies with typically lower fees, intraday liquidity and a tax-friendly structure.

In the end, advisors who incorporate alternatives into portfolios might help clients reduce their stress while increasing their bottom-line results.

Ron DeLegge II is the founder of ETFguide.com and author of several books, including Habits of the Investing Greats and Portfolio Architecture: A Handbook for Investors.