How to Seek Low Correlation ETFs for Added Diversification - dummies

How to Seek Low Correlation ETFs for Added Diversification

By Russell Wild

There are some sector-based ETFs that are better choices than others for additions to a portfolio that mostly features style investments. When deciding what sector investments to add to your portfolio, you should look for low correlation to the rest of the stock market.

Some sectors, or industry subsectors, even though they are part of the stock market, tend to move out of lockstep with the rest of the market. By way of example, consider REITs: real estate investment trusts.

Another sector that fits the bill, at least of late, is energy. Yes, Exxon Mobil and Chevron are part of the entire market, but they tend to zig when everything else zags (in part because when the price of oil rises, these companies profit more, while the rest of the economy, at least outside of Texas, suffers).

For example, consider that in 2002, when the total U.S. stock market tanked by almost 11 percent, REITs were up 31 percent. The year 2005 was pretty lackluster for the total stock market, yet energy stocks were up 31 percent.

Of late, the basic materials (sometimes called “natural resources”) sector has shown a delightful lack of correlation with the rest of the market. Presently, this sector — comprised of companies involved in the mining and refining of precious and industrial metals, and the manufacture of chemical and fertilizer products — has thus far in 2011 shown the greatest one-year return of all major industry sectors.

Of course, there are years when it works the other way, and these sectors may fall way short of the overall market.

If you decide to build your portfolio around industry sector funds, at the very least you should dip into the style funds to give yourself the value/small cap tilt. That’s especially true if you use SPDRs to build your sector portfolio. This fund group is especially weighted toward large cap.