One of the primary selling points of ETFs is that at the asset class enables investors to enhance portfolio diversification and do so cost effectively. For equity investors, there are hundreds of ETFs that are home to thousands of stocks. Investors looking to fortify fixed income diversity have plenty to embrace, too, because there are some diversified bond ETFs that home to thousands of bonds.
Portfolio diversification has its advantages. It can help investors reduce risk and correlations, gain exposure to an increased number of asset classes, market capitalization segments and regions and mitigate exposure to company-specific risks.
Of course, the aim of the game with diversification is ensuring that assets that may appear unrelated under the confines of one portfolio can actually work together to reduce and enhance long-term performance.
“A common error in portfolio construction is that of choosing specific investments that may appear to be worthwhile individually, but make little sense when combined in a portfolio,” according to Vanguard. “In the end, this collection of investments does not necessarily form a coherent asset allocation or sub-asset allocation that matches the investor’s objectives and risk tolerance.”
When properly applied, ETFs can be the ideal instruments for adding diversification to your portfolio.
“ETFs are now traded on virtually every major asset class, commodity, and currency in the world,” said Fidelity. “Moreover, innovative new ETF structures embody a particular investment or trading strategy. For example, through ETFs an investor can buy or sell stock market volatility or invest on a continuous basis in the highest yielding currencies in the world.”
Here are some of the most diverse ETFs to consider across multiple strategies and asset classes.
Vanguard Total Market ETF (VTI)
Expense ratio: 0.03% per year, or $3 on a $10,000 investment.
In multiple ways, the Vanguard Total Market ETF (NYSEARCA:VTI) is a big ETF. Home to $119.5 billion in assets under management, this Vanguard fund is one of the largest ETFs in the world. VTI also holds 3,600 stocks, good for one of the largest rosters among all equity-based ETFs and enough to imply some level of diversity.
With VTI, ETF diversification is sourced through the fund’s lack of dependence on any of its holdings. The fund’s top 10 holdings combine for just 18.80% of its weight, according to issuer data. Bottom line, VTI meets one standard for ETF diversification simply because it holds a massive number of stocks and it has the added benefit of being one of the cheapest ETFs on the market.
However, over long holding periods, investors should expect VTI to differ wildly from broad market benchmarks. Over the past three years, the fund has barely outpaced the S&P 500.
VanEck Vectors Municipal Allocation ETF (MAAX)
Expense ratio: 0.36%
At just two months old, the VanEck Vectors Municipal Allocation ETF (CBOE:MAAX) is the newest ETF mentioned here and while it focuses on a specific corner of the bond market, MAAX meets the standards of being a diverse ETF.
Traditional municipal bond ETFs focus on a specific credit quality or duration and although some of those funds may hold a lot of bonds, the emphasis on a particular objective, high or low credit quality or long or short duration; reduces diversification. MAAX solves that scenario and does so in effective, unique fashion.
MAAX is an ETF of ETFs, holds some of the other VanEck municipal bond ETFs and allocates just over 70% of its weight to the VanEck Vectors High-Yield Municipal Index ETF (CBOE:HYD) and the VanEck Vectors AMT-Free Long Municipal Index ETF (CBOE:MLN). Add those holdings up and MAAX has exposure to nearly 6,000 muni bonds of varying credit quality, duration and yield.
SPDR SSGA Global Allocation ETF (GAL)
Expense ratio: 0.35%
For investors that look the traditional 60/40 equity/fixed income split for diversification, the SPDR SSGA Global Allocation ETF (NYSEARCA:GAL) is an ETF to consider. Like the aforementioned MAAX, GAL is an ETF of ETFs and most of its 22 holdings are other SPDR funds.
The equity portion of this diversified ETF’s roster is designed to top the MSCI ACWI IMI Index while fixed income portion aims to beat the widely followed Bloomberg Barclays U.S. Aggregate Bond Index. GAL’s fixed income holdings include junk bonds, international bonds, TIPS and intermediate-term U.S. Treasuries.
Familiar holdings in this diversified ETF include the SPDR S&P 500 ETF (NYSEARCA:SPY) and the SPDR Portfolio Emerging Markets ETF (NYSEARCA:SPEM). With this diversified ETF, investors should expect higher income than the S&P 500 or 10-year Treasuries.
Invesco Zacks Multi-Asset Income ETF (CVY)
Expense ratio: 0.88%
As its name implies, the Invesco Zacks Multi-Asset Income ETF (NYSEARCA:CVY) is a multi-asset ETF, indicating there is some level of diversification offered by this fund. There are actively managed funds in the multi-asset realm, but CVY is an index-based product as it tracks the Zacks Multi-Asset Income Index.
That benchmark “is comprised of domestic and international companies, including US listed common stocks, American depositary receipts (ADRs) paying dividends, real estate investment trusts (REITs), master limited partnerships (MLPs), closed-end funds and traditional preferred stocks,” according to Invesco.
CVY has nearly 150 holdings and while many of those are common stocks, the fund holds enough high-yielding assets to push its 30-day SEC yield to 4.22%, indicating that it can be used as a complement to a standard equity fund like VTI. CVY adds diversification by being mixed across large-, mid- and small-cap equities.
Vanguard Extended Market ETF (VXF)
Expense ratio: 0.07%
Think of the Vanguard Extended Market ETF (NYSEARCA:VXF) as diversification enhancer because the objective of extended market funds, such as VXF, is to fill in the blanks created by large cap-heavy funds.
Even a diverse ETF like the aforementioned VTI is likely to tilt toward large-cap stocks despite its massive roster. That creates some voids, but those gaps can be filled by a fund such as VXF, which is entirely devoted to mid- and small-cap names. And like its large-cap peer VTI, VXF is a diverse ETF in terms of sheer number of holdings, which total 3,262.
Adding to its diversification utility, VXF’s holdings have a median market value of $4.6 billion, putting the fund at the lower end of mid-cap territory and the fund’s top 10 holdings combine for just 5.50% of the fund’s weight, indicating single-stock risk is minimal.
Cambria Global Asset Allocation ETF (GAA)
Expense ratio: 0.30%
The Cambria Global Asset Allocation ETF (CBOE:GAA) is another example of a diverse ETF that boosts diversification through the ETF of ETFs methodology. GAA’s asset selection universe includes domestic and foreign stocks, bonds, real estate, commodities and currencies.
“Since the GAA ETF is meant to be a buy and hold allocation, the portfolio is simply rebalanced back to target weightings each year, which broadly tar-get a 40% allocation to global stocks, a 40% allocation to global bonds, and a 20% allocation to real assets, such as commodities and currencies,” according to Cambria.
About half of GAA’s top 10 holdings have significant exposure to international bonds and stocks, giving investors an opportunity to take advantage of some compelling ex-US valuation discounts while gaining a higher income profile. GAA has a dividend yield of almost 3%.
GraniteShares HIPS US High Income ETF (HIPS)
Expense ratio: 1.30%
The GraniteShares HIPS US High Income ETF (NYSEARCA:HIPS) provides diversification across some popular high-yielding asset classes, such as master-limited partnerships, real estate investment trusts, closed-end funds, and business development companies. This diverse ETF recently got a new benchmark, which could further up its diversity.
“The revised index, officially renamed the TFMS HIPS Index, rolled out July 1, 2019, and includes several key enhancements that could potentially benefit investors,” according to a statement issued by GraniteShares.
The new index HIPS also takes steps to minimized volatility, a trait that could work in favor of investors.
“First, a quantitative screen was applied to the stock selection process to help minimize index volatility and dampen the effect of recent market uncertainty on index return,” said GraniteShares. “Additionally, a cap was introduced that limits the index to holding no more than 60 high-income securities, versus 300 securities measured in the original index.”
Todd Shriber does not own any of the aforementioned securities.
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