Start with the assumption that an equity portfolio for a U.S.-based investor is 75% domestic (in Spyders (SPY)) and 25% foreign (in iShares MSCI EAFE (EFA)). To reduce volatility and correlation but still capture most of a big move up, let's cut the Spyders weight to 50% and reallocate that 25% of the capital in 5% increments to:
- Calamos Convertible Opportunities and Income Fund (CHI - Get Report): A convertible bond fund that yields 9%. Convertibles tend to be less sensitive to interest rates because the bonds can convert into common stock.
- PowerShares DB Currency Harvest Fund
(DBV): Goes long the three highest-yielding currencies in the Group of 10 and short the three lowest-yielding currencies in a carry trade of sorts, as I've
- CurrencyShares British Pound Sterling Trust (FXB): This very small fund (averages just under 7,000 shares daily and a market cap that doesn't quite make $60 million) simply owns British pounds and goes up when the pound goes up against the U.S. dollar (and down in the reverse case).
- Alpine Global Dynamic Dividend Fund
(AGD - Get Report): A closed-end fund that makes use of the
- BlackRock Enhanced Equity Yield Fund
call-writingclosed-end fund that appears to be a little less volatile than other funds that use the same general strategy.
Before I deconstruct this mix, note the most important thing about these five products: All rely on different strategies to achieve their respective results.
An important element of diversification is not being overly exposed (that is, too vulnerable) to one type of trade going bad. For example, EEF is a call-writing closed-end fund. I am a huge fan of the concept, but in practice don't allocate even 5% to the theme. Or if something bad were to happen to the dividend-capture strategy that AGD is based on, there shouldn't be any lasting impact on the other products in our imagined portfolio -- and therefore the whole portfolio.
Low correlation to S&P
|Ticker||Beta||Correlation to SPX|
| Good Stress Test
Most portfolio enhancements held up better than the portfolio's original mix during the first quarter
|Click here for larger image.|
|Source: Yahoo! Finance|
An investor implementing the above portfolio on the first trading day of the year would have been up 6.58% as of the close on May 25, compared with a return of 7.53% (including dividends) for being 100% invested in Spyders during the same period. I would expect the results to look more favorable once a year's worth of dividends has been paid. This sort of trade-off is a compelling. Keep in mind that this is just an example, but I hope this serves as springboard for you to develop your own ideas.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider PowerShares DB Currency Harvest Fund, CurrencyShares British Pound Sterling Trust and BlackRock Enhanced Equity Yield Fund to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.