Want Lower Risk? Try to Diversify
You can see that LQD and HYG tend to move in different directions, which is a good sign in terms of diversification. When the assets in a portfolio don’t move in synch, the volatility of the portfolio is reduced. This is why a diversified portfolio usually experiences less risk than the weighted average risk of its constituents – and often less risk than its least risky constituent.
If managing risk is one of your investment goals, as it is for IYLD, then diversification is a practice you’ll want to get acquainted with.
Market Realist – Treasuries are a critical part of a portfolio, as they add great diversification benefits.
The iShares Morningstar Multi-Asset Income ETF (IYLD) holds ETFs that are exposed to different kinds of risks, as we saw in the previous parts. This makes it a well diversified ETF.
The graph above shows the correlation between some of the holdings of the IYLD, including long-dated Treasuries (TLT), high yield corporate bonds (HYG), investment-grade corporate bonds (LQD), and high dividend shares (HDV), considering monthly returns over the last ten years.
The correlation coefficient lies between +1 and -1, where +1 means the two assets move in lockstep with each other and -1 means that the two assets move in inverse proportion to each other. A correlation of zero between two assets is ideal.
As you can see, TLT actually has negative correlations with HDV and HYG. However, it is also close to zero, which is ideal. TLT has a correlation of +0.5 with LQD though. The correlations between the other three lie in the range of +0.2 and +0.7, which is good. However, the Treasuries (IEF) add great value to IYLD, as they follow a different trajectory compared to the other assets.
Read Where Dividend Investors Are Seeking Income to find out which sectors could see a rise in dividend yields.
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