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Most investors understand the role portfolio diversification plays in minimizing risk. Unfortunately, many people think diversification simply means investing in exchange-traded funds that hold a number of different stocks.
Source: flickr.com/Will McGugan
Owning shares of a diversified U.S. equities ETF such as the SPDR S&P 500 ETF Trust (NYSEARCA: SPY ) is certainly a more diversified strategy than owning a handful of individual stocks. However, investors seeking true diversification should look outside of only large-cap U.S. equities.
From March 1, 2008, to March 1, 2009, the SPY ETF dropped 44.6%. Even exposure to 500 different stocks doesn't provide diversification when the entire stock market tanks.
Instead, investors should remember that true diversification involves investing in assets that have zero price correlation . Here's a look at three liquid ETFs that fit that description.
ETFs For Portfolio Diversification: iShares Barclay's TIPS Bond Fund (ETF) (TIP)
Expenses: 0.2%, or $20 per $10,000 invested annually
Not surprisingly, the majority of the major ETFs that have near-zero correlation to the S&P 500 are bond ETFs. Out of this group, the iShares Barclays TIPS Bond Fund (ETF) (NYSEARCA: TIP ) has the highest daily trading volume at more than 1.5 million. With more than $21.3 billion in total assets and plenty of daily volume, the TIP ETF should be easy for investors to buy or sell at a moment's notice.
"TIPS" is an acronym for "Treasury inflation-protected securities." Not only can these U.S. government-issued bonds protect against stock market volatility, they are also designed to protect against inflation.
In other words, TIPS produce a real rate of return that is guaranteed by the U.S. government, making them one of the safest fixed-income investments out there.
In terms of diversification, the TIP ETF has a 0.04 correlation with the SPY ETF. That's almost zero, making it a great starting point for investors looking for true portfolio diversification.
ETFs For Portfolio Diversification: iShares MSCI Global Gold Miners ETF (RING)
Bonds are one popular way to diversify an equity-heavy portfolio. Gold is another.
The iShares MSCI Global Gold Miners ETF (NYSEARCA: RING ) ETF is a fund that invests in some of the largest international gold mining stocks. While U.S. investors may be much more familiar with the popular Market Vectors Gold Miners ETF (NYSEARCA: GDX ), the RING ETF offers even more diversification. The fund is focused on international exposure to both emerging and developed markets.
While this fund is technically comprised of stocks, gold miners aren't typical stocks. As RING's 0.05 correlation with the SPY suggests, gold miners don't trade along with the rest of the stock market. Instead, they are closely correlated with gold prices .
In fact, the RING EFT has a 0.78 correlation with the SPDR Gold Trust (ETF) (NYSEARCA: GLD ).
The RING fund has $252 million in total assets and a daily trading volume of about 258,000. Those numbers indicate plenty of liquidity for retail investors.
As an added bonus for investors seeking portfolio diversification, the RING ETF has a relatively low 0.28 correlation with the TIP ETF as well.
ETFs For Portfolio Diversification: Teucrium Corn Fund (CORN)
The Teucrium Corn Fund (NYSEARCA: CORN ) is structured to have the daily change of the fund's net asset value reflect the daily changes in corn futures contracts. In other words, as the name and ticker imply, CORN is a way to invest in corn.
Investing in corn may seem strange and uninspiring, but diversification isn't about huge returns. It's about managing risk. The CORN ETF has a near-perfect -0.01 correlation with the SPY.
The fund is on the small side, with only about $79 million in total assets. However, it averages around 104,000 in daily volume, which should provide plenty of liquidity for most retail investors.
There are a number of more popular agriculture ETFs out there. However, the CORN ETF is specifically designed to reduce the adverse impact of contango by diversifying across multiple maturities. That unique structure makes the CORN a more appealing option as a long-term inflation hedge. Just be conscious of the expense ratio, which currently sits at 2.89%.
The CORN ETF shares a -0.02 correlation with TIP and a 0.09 correlation with RING. These three ETFs added to the SPY create a portfolio of four investments with nearly zero internal price correlation.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.
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