EC These Alt ETPs Are Proven Diversifiers

That 1.14 ratio is our bright line. Any attempt to build a more diverse portfolio by weaving in an alternative ETP into a SPY/AGG mix will show some measure of success if it results in a diversification ratio exceeding 1.14.

If we make room for a 10 percent alternative exposure by reducing the SPY allocation to 50 percent, all 34 of the resulting portfolios earn diversification ratios better than 1.14. Twenty-three, or about two-thirds, are within one standard deviation of the benchmark. It’s the top 10 portfolios— the ones with the highest diversification ratios— that deserve our immediate attention, however. Table 1 contains these asset mixes set against the benchmark 60/40 portfolio.

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At the top of the table, with a 1.48 diversification ratio— four standard deviations above the benchmark—is the portfolio constructed with the AGFiQ U.S. Market Neutral Anti-Beta ETF (NYSE Arca: BTAL), a fund that takes long positions in low-beta stocks while shorting high-beta issues. This portfolio has the distinction of having the lowest r-squared coefficient against SPY and is the only one that earns positive alpha, in great part owing to BTAL’s volatility dampening.

The second-place portfolio is built around the iPath U.S. Treasury Steepener ETN (Nasdaq: STPP), a note that tracks nominal futures spread: long two-year versus short 10-year T-note contracts. The STPP strategy aims to produce gains as yields on longer-term paper rise relative to short-term debt. The ETN’s neutral beta stance has an ameliorative effect on the benchmark alpha even as it gooses up the r-squared coefficient.

Third place belongs to a portfolio that includes the AGFiQ U.S. Market Neutral Value ETF (NYSE Arca: CHEP), a fund that pits long positions in value stocks against shorts in growth names. Over the past two years, value’s been mostly a drag on portfolio performance.

In the fourth position, the portfolio fashioned with the Invesco DB G10 Currency Harvest (NYSE Arca: DBV) obtains the benefit of currency carry trade strategy, along with the attendant foreign exchange risk. Using forward contracts, the DBV fund takes long positions in currencies supported by high-interest rates while shorting low-rate currencies.

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Disclosure: None.

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