I know, overall, the market is up, up, up and you are feeling great about your portfolio. I know you don’t want to hear that this is not how your portfolio should behave, because you’ll think I’m some perma-bear or killjoy. And you sure don’t want to hear about alternative ETFs.
But, please, just listen.
A properly diversified, long-term portfolio, does not have assets that all move up or all move down at the same time, based on what the market is doing. In fact, that’s the worst kind of portfolio to have. It means your portfolio is highly correlated to the market.
You don’t want a highly correlated portfolio; trust me. You want non-correlated assets, involving alternative ETFs, because they reduce risk.
A non-correlated asset, also known as an “alternative investment”, is a security that does not move lock-step with the direction of the overall stock market. If the overall market moves up, it may decline in value. If the market moves down, it may move up. Or, it may move in the same direction with the market, but with less volatility. So if the market falls 20%, a non-correlated asset may only fall 8%.
Why are non-correlated assets important? Until 1983, nobody thought they were.
Then a Harvard business professor named John Lintner delivered a landmark paper entitled, “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds.” The bottom line, however, was that portfolios of stocks and/or bonds, combined with investments called “managed futures”, showed substantially less risk at every possible level of expected return than portfolios of stocks and/or bonds alone.
In other words, you need to have non-correlated assets like alternative ETFs in your portfolio. Things like managed futures are just a start.
My stock and options advisory newsletter, The Liberty Portfolio, actively engages in the purchase of non-correlated assets, and it engages in swing and options trades to reduce risk, increase current income and it is targeted for a minimum ten-year holding period.
Here are three examples of alternative ETFs you must have in your portfolio, and why you should have them.
Alternative ETFs to Buy: T. Rowe Price Global Multi-Sector Bond Fund (PRSNX)
Source: Kevin Gill via Flickr
T. Rowe Price Global Multi-Sector Bond Fund (MUTF:PRSNX) is considered a managed futures fund. Its 3-year annual average return is 4.37% with a standard deviation of 3.15. That means the fund has a 95% certainty in any given year of returning between – 2.0% and +10.6%.
Now think about that range. Do you prefer that range or the range of the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), which, over the past ten years, has a 95% certainty of delivering returns in any given year between -22% and +38%?
Trust me, you don’t want to be sitting on the SPY in a year where it is down 22%.
That’s why you include something like PRSNX in a portfolio, because that lower volatility will temper the wider volatility, aka risk of the other assets.
Alternative ETFs to Buy: IndexIQ IQ ARB Merger Arbitrage ETF (MNA)
IndexIQ IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) is pretty simple. Generally, in a merger, one stock rises and another falls. MNA seeks to capitalize on the spread between the current market price of the target company’s stock and the price received by the holder of that stock upon consummation of the buyout-related transaction. In addition, the underlying index includes short exposure to the U.S. and non-U.S. equity markets.
Again, we look at returns and standard deviation. Its 5-year annual average return is 4.97% with a standard deviation of 3.4. That means the fund has a 95% certainty in any given year of returning between -1.8% and +11.8%. Adding this to a portfolio tamps down volatility and reduces risk.
Alternative ETFs to Buy: ProShares Hedge Replication ETF (HDG)
ProShares Hedge Replication ETF (NYSEARCA:HDG) tries to duplicate the seven major hedge fund strategies represented by about 2,000 hedge funds, and use certain derivatives to get as close to that universe as possible.
Its 5-year annual average return is 2.5% with a standard deviation of 3.4. That means the fund has a 95% certainty in any given year of returning between -4.3% and +9.3%. Long story made short, adding this to a portfolio tamps down volatility and reduces risk.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.