An El-Erian Fund for the Masses Using ETFs

Mohamed El-Erian has quickly become an investment guru.

El-Erian, the CEO of Pimco, the world's largest bond-fund manager, has interesting ideas about portfolio construction and the evolution of diversification. He devotes a large portion of his latest book, "When Markets Collide," to a new type of portfolio. I will now explore some simple choices that fit in with El-Erian's concept.

Here's the breakdown:

Equities Domestic 15% Foreign Developed 15% Emerging Market 12% Private Equity 0% Bonds Domestic 9% Foreign 15% Real Assets Real Estate 5% Commodities 11% TIPS 5% Infrastructure 5% Special Opportunities 8%

For the domestic equity allocation, 10% goes to PowerShares S&P 500 Buy Write Portfolio (PBP). The track record of the buy write index has been to outperform the S&P 500 over the entire stock-market cycle, only lagging when the market rallies, as it did in 2003. iShares S&P 600 Small Cap ETF (IJR) would take the other 5% in domestic equities. In the early stage of a stock-market cycle, small-cap stocks tend to outperform large caps. IJR helps capture that effect.

Many investors use iShares MSCI EAFE ETF (EFA) for developed country equities, but it is heavy in Japan, at 25%, so I prefer 10% be allocated to WisdomTree International Large Cap Dividend ETF (DOL), which only puts 9.7% in Japan. There is now a choice among foreign small caps. The SPDR S&P International Small Cap Index Fund (GWX) is lighter in financials than similar funds and gets the other 5% in this category.

In emerging markets, I use the PowerShares BLDRS Emerging Market 50 Index Fund (ADRE). Interestingly, small-cap emerging markets ETFs don't do any better than large-caps.

El-Erian likes private equity. Because no ETF can mimic that category adequately, I omitted it from the portfolio. El-Erian recently said this might be the most difficult part of the market for do-it-yourselfers to access.

The ETF industry has been creating more fixed-income choices, which is a boon for investors. For domestic bonds, I would suggest 6% to iShares Barclays 1-3 Year Treasury Bond ETF (SHY) and 3% to iShares Barclays Agency Fund (AGZ). The yields are lousy (about 2% and 2.5%, respectively) but if yields rise, longer-dated bonds and bond funds will tumble. Anyone so inclined could buy individual fixed-income issues. The 15% target for foreign bonds could be easily captured with iShares S&P Citigroup International Treasury (IGOV). SPDR has a similar product, but it has emerging market exposure, whereas IGOV does not.

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