In today's volatile market environment, investors are often in search of ways to diversify their portfolios. In the past, diversification simply meant having a solid mix of both stocks and bonds. However, because of the advent of index investing, the correlation between different stocks has risen substantially. Meanwhile, due in part to actions by the Federal Reserve, bonds have not maintained the strong inverse relationship to the stock market that they always have had in the past.
As you can see, yields on the 30-Year Treasury bond are close to record lows while the stock market is far off its lows.
The quest for diversification has sent investors into new products such as volatility futures products such as iPath S&P 500 VIX Short-term Futures ETN (VXX) and Velocity Shares Daily 2x VIX Short-term ETN (TVIX). However, these products have significant flaws that have led to massive loses for investors. Investors have also turned to the commodity markets in search of diversification. This strategy has played out somewhat better as gold (GLD) and oil (USO) have shown the ability to trade independently of the stock and bond markets.
Investors should consider buying American Capital Agency Corp (AGNC) because it has a low correlation with almost all other investments (except other mortgage reits).
As you can see, at times AGNC has moved with the stock market and at times AGNC has moved inversely from the stock market. During the stock market sell-off in 2008, AGNC did not plunge with the stock market. However, AGNC did rally with the stock market following the bottom in 2009. Interestingly, AGNC only recently surpassed its 2009 highs while the stock market as a whole has moved much higher from those levels. At the very least, the correlation between AGNC and the stock market in general is much weaker than other stocks.
It is also important to look at AGNC versus Treasury bonds. As you can see in the chart below, at times AGNC has moved inversely with bonds and at times AGNC has moved in the same direction as bonds. This chart proves that, similar to stocks, AGNC's correlation with bonds is limited.
While AGNC's diversifying property is important, it is not the only reason to buy.
Arguably the most important thing to consider when evaluating AGNC is the dividend. Currently, AGNC pays a massive dividend of $5.00 per share or 15.75%. While this yield seems "to good to be true," AGNC has proven that it can pay a dividend of this level.
Because of AGNC owns liquid securities, the best way to value AGNC is book value. As you can see in the chart below, AGNC is trading at cheap valuation of just 1.146 times tangible book value.
Like all investments, AGNC does have its fair share of risks. The greatest risk that the company faces would be an inversion of the yield curve. However, because of the Federal Reserve's commitment to -low interest rates through 2014, the risk of a yield curve inversion is very low. Other Seeking Alpha contributors have outlined some of the other risks facing AGNC. However, I tend to agree with the more bullish thesis as stated here.
I believe investors should consider buying AGNC because of its diversification properties. While AGNC does face its own unique risks, these risks are very different from the risks facing other securities in investor's portfolios.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.