NEW YORK (TheStreet) -- Too much correlation in your portfolio can be a dangerous thing, says Brian Jacobsen, chief portfolio strategist at Wells Fargo Advantage Funds.
"Investors need to look at their statements on a daily basis to see whether they are up 1% when the S&P 500 is up 1%," says Jacobsen. "Similarly, they should be skeptical if their holdings are down in lock-step with the S&P 500. That's a good indication that you might want to tweak your portfolio to lower those correlations."
One way to reduce correlation in a portfolio is to add liquid alternative funds that employ hedged strategies such as long/short, global macro or merger arbitrage. Each strategy might behave differently in the market, so Jacobsen suggests adding more than one to create a "benchmark-free type of approach."
"It's about building diversified-thinking into managing your money as opposed to checking the boxes to have small, large and mid-cap funds filled out," says Jacobsen.
As to how much an investor should allocate to liquid alternative funds, Jacobsen says it depends on the individual investor (of course), as well as the future actions of the Federal Reserve. The rate hike which was once a lock for June is now widely believed on Wall Street to be delayed until September or even December, thereby increasing volatility and the need for additional portfolio protection.
"There is enough ambiguity out there due to justify having anywhere between 10% and 15% of a portfolio in liquid alternative funds," says Jacobsen. "Once that cloud lifts and that ambiguity goes away you can take some of that off the table."