In the sporting world, and in the world of investing, the best offense may be a great defense. Without question, there have been moments when I’ve highlighted the beneficial aspects of lower-risk equity ETFs such as SPDR Select Health Care (XLV) and SPDR Select Utilities (XLU).
In the same spirit, you may also lower risk without the sacrifice of capital appreciation potential; you can pursue low-correlating growth assets that reduce overall portfolio risk through genuine diversification.
For instance, some ETFs may be highly correlated with the S&P 500 SPDR Trust (SPY) such that you are capturing “beta.” Yet if you also add low correlating ETFs that seek ”alpha” (zinging when the market is zanging), both groups may reach the growth/income goal(s) via completely separate paths.
Consider investments that, by themselves, might seem volatile. The iShares Biotech Fund (IBB) must contend with the uncertainty of healthcare legislation as well as the speculative nature of the sub-segment. Market Vectors Gold Miners (GDX) soars or swoons with even mild movements of the underlying commodity as well as currency disruptions. And KBW Regional Banking (KRE)? The exposure to commercial real estate, ongoing bank shutdowns and general unease regarding the extension of credit is enough to create doubt.
Perhaps, then, it’s not so surprising to discover that none of these equity ETFs is highly correlated (0.75-1.0) with the S&P 500 SPDR Trust (SPY). In fact, each of them has a relatively low correlation for stock assets of just 0.5 over the last 6 months.
Yet watch what happens to a portfolio when you couple low correlating ETFs with an equal number of high correlating ETFs. In the example below, I used iShares NYSE 100 (NY), iShares Russell 1000 (IWB) and PowerShares Nasdaq 100 (QQQQ).
|An “Alpha-Beta” Stock ETF Portfolio|
|6 Month % (Approx)|
|High Correlation With S&P 500 (SPY)|
|iShares NYSE 100 (NY)||7.3%|
|iShares Russell 1000 (IWB)||9.8%|
|PowerShares Nasdaq 100 (QQQQ)||12.7%|
|Low Correlation With S&P 500 (SPY)|
|iShares Biotechnology (IBB)||10.1%|
|Market Vectors Gold Miners (GDX)||12.7%|
|KBW Regional Banking (KRE)||14.7%|
|Total Portfolio Return||11.2%|
|S&P 500 (SPY) Total Return||9.2%|
Again, individually, funds like IBB, KRE and GDX may be very scary prospects. However, the fact that these funds haven’t been moving in the exact same fashion as the S&P 500 over 6 months may make them more attractive as part of a well-constructed total portfolio.
Disclosure Statement: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The company does not receive compensation from any of the fund providers covered in this feature. Moreover, the commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.