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:
For the domestic equity allocation, 10% goes to
PowerShares S&P 500 Buy Write Portfolio
. 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
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
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
, 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
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
. 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
and 3% to
iShares Barclays Agency Fund
. 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
. SPDR has a similar product, but it has emerging market exposure, whereas IGOV does not.
Real estate is also difficult to capture. During the financial crisis, REITs offered no diversification benefits. I have not had real estate exposure for clients since late 2007, but for investors who believe in the asset class, the
WisdomTree International Real Estate ETF
offers a mix of property operators and owners in real-estate markets that are less mature than ours. These less-mature markets have a better chance of capturing a cyclical upswing than do U.S. REITs.
In the past few years, most investors have come to learn a lot more about commodities than they previously knew. El-Erian advocates 11% in commodities, which is more than I prefer. Being true to El-Erian's portfolio, I would allocate 6% to
SPDR Gold Trust
and 5% to
PowerShares Agriculture Portfolio
. I am not a fan of the broader commodity funds because of their exposure to crude oil.
El-Erian considers TIPS to be separate from fixed income. The
iShares Barclays TIPS Fund
SPDR Barclays Capital TIPS Fund
are the easiest ways to access the space.
Infrastructure is a compelling theme, and there are several ETFs in existence. The truest ETF exposure might be the
iShares S&P Global Infrastructure Fund
because it is heavy in industrial companies that will build roads, airports and the like.
Thus far, the portfolio takes no single-stock risk, but that is not ideal for building a diversified portfolio. There are plenty of examples of foreign stocks that stand to be important to the building up and out of infrastructure in emerging markets.
China Railway and Construction
would seem to have its finger on the pulse of all things infrastructure in China including railroads, highways, commuter rails, airports and hydroelectricity. A combination of IGF and a stock like CWYCY could be an effective way to capture the effect El-Erian is looking for.
Special opportunities can be anything you understand and are willing to pay close attention to. Some examples of this could include small emerging market countries. I just wrote an
GlobalX Colombia ETF
. There will be more ETFs that focus on small countries in the future. One special opportunity now is volatility. A couple of weeks ago, iPath listed the
S&P 500 VIX Short Term Futures ETN
. VXX is not the VIX, but it is close. Something like water via the
PowerShares Water Portfolio
could be another example.
The bigger context is recognizing how we get the return our financial plans require may be changing, and we need to change with it.PBP, ADRE, GLD, IGF, DBA
At the time of publication, PBP, ADRE, GLD, IGF and DBA were client and personal holdings, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
to send him an email.