A Diversified Portfolio Should Take Risks, But Not a Lot

On Tuesday I am flying to Miami to speak at the World Series of ETFs East on Wednesday and Thursday.

One of the panels I am on will discuss how to integrate ETFs into an investment management practice. Besides the obvious of just 'Buy them', the topics will include how to research them, how to explain them to clients and what the drawbacks are.

The other, and probably more interesting, panel will be about reducing portfolio correlation with fixed income ETFs. That the global TIPS ETF just listed under ticker WIP should make the conversation all the more interesting.

There are a couple of other sessions that I plan to sit in on when I'm not out on the water in a speed boat or racing through the streets in a Ferrari (humor attempt).

The evolution of the investment products (not just ETFs) and the strategies that are now more easily accessed is a great thing for do-it-yourselfers, in that very sophisticated investment vehicles can be constructed for individual sized investors. I've tried to delve into some portfolio ideas both here and in articles I've written for TSCM, and the cool thing is that the concepts become dated very quickly, as new products come out, or as readers point out things I've never seen before.

This past week an email came in telling me about the Arctic Glacier Income (AGUNF.PK) which is a Canadian trust whose business is selling ice cubes and blocks. The fund recently got hit hard in the face of an ice industry collusion allegation that has also hit Reddy Ice (FRZ). Ice collusion, wow.

Both of these are fairly recession-proof (good), paid a high dividend even before the price drops (this may or may not be good, you need to look under the hood), and both are very levered, FRZ more so (which is not so great).

In general 10% yielders are risky. I have said this before as have some reader. Something that yields 10% in a 5% world, generically speaking, is risky. You either know what the risk is or you don't.

There is nothing wrong with allocating a few percent to a levered, high yielding product that you feel is sound. To be clear I am offering no opinion either way on AGUNF or FRZ. A diversified portfolio should take some risks, maybe not a lot but some. A modest weight in something that blows up would be a bummer but not ruinous. Depending on the account size, 5% split between a hydro fund, one of the plane leasing companies and some other high yielding segment (assuming all three are properly researched) is far from crazy.

Comments

[whisperonth...:]

Ahhh, but the excitement when they go up gets your blood flowing!

2008 Mar 23 08:00 AM

[Subhash Juneja:]

Well thought out article. ETFs are the best friend of small investors and I am glad that people like Mr. Nusbaum freely share the wealth of knowledge they possess. Keep up the good work.

2008 Mar 23 12:00 PM

[Roger Nusbaum:]

Whisper, I don't minimze the rush, seriously i do not but that rush pales to the pain of a flush:->>

Subhash, thank you for the kind word.

2008 Mar 23 01:19 PM

[Purl Gurl:]

Subhash Juneja writes, in part,

"ETFs are the best friend of small investors...."

Exchange Traded Funds (ETF) are usually not for "small investors" as you suggest. Typically, an investor needs to drop ten grand into an ETF to overcome fee based erosion of investor equity. Ten grand is not an insignificant amount of money.

An ETF is a safer investment when markets are stable. We do know today's markets are far from stable. An example is an ETF based on the financial sector has lost an average twenty-five percent in equity value.

While an ETF provides a loss cushion through specific sector diversification in securities holdings, should an entire sector suffer losses across all related securities, ETF losses can be multiplied by extreme losses for specific securities within an ETF portfolio. This is well exemplified by my financial sector losses previously cited. A more specific example is being vested in an ETF which contains Bear Stearns in the securities mix.

An ETF will almost never exceed average index growth in a specific sector. Through diversified holdings there will be, inherently, some securities which lose value contrary to overall average growth of a sector. Potential for ETF growth is almost always slightly less than an index average. Savvy and seasoned investors usually can well outperform an index average. However, individual investing does require a lot of research and time, to be successful.

During times of market stability and growth, an ETF is a very good choice for those who want to assume less risk in the markets and need to have others decide which securities to buy and how much diversification is needed for acceptable growth and lower risk.

Contrasting this, during times of market instability, such as now, an ETF can be amongst the most high risk investments made. This risk is concentration of investment in specific sectors such as the financial sector or the precious metals sector.

There are advantages and disadvantages with these “exotic mutual funds” we know as Exchange Traded Funds. Rather than launch into a lengthy discussion of ETF basics, my sincere suggestion is readers spend a lot of time carefully researching ETF basics to determine if an ETF investment or ETF trading is best for you and your individual needs.

Always keep in mind when a person promotes a certain investment strategy, this is almost always done so for self-interest reasons; those of Wall Street are certainly not your friends.


Okpulot Taha
Choctaw Nation

2008 Mar 23 01:53 PM