Seeking Diversification - Top 3 ETFs

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Includes: AMLP, GDX, PGX
by: Marius Bausys

Summary

Most efficient diversifiers tend to have a 'spin' to traditional funds.

They also demonstrate low correlation and beta with S&P 500.

Volatility can be a positive factor in portfolio diversification context.

In 1952 Noble Prize winner Harry Markowitz described diversification as the only 'free lunch' when seeking investment returns. Most investors are well familiar with the concept of diversification but it is not always easy to find securities that would fit your portfolio well from the risk perspective. Ever since I launched a freely available investor tool InvestSpy almost a couple of years ago, I have tested countless portfolios and individual securities searching for efficient diversifiers. In this article I would like to share top 3 equity ETFs that make the most frequent appearances on my results table.

No. 3 - ALPS Alerian MLP ETF (NYSEARCA:AMLP)

AMLP provides exposure to the overall performance of the U.S. energy infrastructure Master Limited Partnership (MLP) asset class. MLPs are publicly traded partnerships engaged in pipeline transportation, storage and processing of energy commodities.

Other closely related products: JPMorgan Alerian MLP Index ETN (NYSEARCA:AMJ), UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPI)

No. 2 - PowerShares Preferred Portfolio ETF (NYSE:PGX)

PGX invests in fixed rate preferred stocks issued in the U.S. domestic market. Preferred stockholders are generally entitled to a fixed dividend rate that is subordinate to debt but senior to dividends on common stock.

Other closely related products: iShares U.S. Preferred Stock ETF (NYSEARCA:PFF), PowerShares Financial Preferred Portfolio ETF (NYSE:PGF)

No. 1 - Market Vectors Gold Miners ETF (NYSEARCA:GDX)

GDX offers exposure to publicly traded companies worldwide involved primarily in gold mining, representing a diversified blend of small-, mid- and large- capitalization stocks.

Other closely related products: Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ)

It is important to note that all of these three funds have a 'spin' to more traditional equity ETFs. GDX acts a combination of stocks and gold, PGX sits somewhere between stocks and bonds, whilst AMLP is linked to all three major asset classes.

Two common risk characteristics that all three above-mentioned funds share are low correlation and low beta vs S&P 500. Coefficient values are amongst the lowest of all available equity ETFs and can be compared here. Therefore, GDX, PGX and AMLP will almost certainly have risk contribution below their dollar weighting given that most traditional portfolios are dominated by the risk arising from the equities component as outlined in one of my previous articles.

Although GDX is clear leader in terms of correlation and beta, this is not the only reason that takes it to the No. 1 spot. Whilst AMLP and PGX demonstrate relatively subdued volatility, GDX is a beast in this respect. And volatility can be a good thing in this context as demonstrated by Salient Partners in the whitepaper where they argue that higher volatility diversifiers are amongst the most powerful tools an investor has.

By no means am I saying that an investor should blindfoldedly invest in these ETFs purely because they look attractive from the portfolio diversification standpoint - after all, GDX and AMLP are currently both on a terrible run. The investment decision should be made in conjunction with other factors that are part of your analytical process, for instance incorporating trend following indicators or fundamental ratios. However, these are definitely the funds that one should at least keep an eye on. If risk can be reduced without sacrificing return, this is what free lunch in the markets is. Bon appetite!

Disclosure: I am/we are long PFF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.