Generally the case for exchange traded fund (ETF) diversification was that it was a protection mechanism for portfolios: If some ETFs went down, having other ETFs in different markets might balance out (or hopefully offset) the losses. However, Gary Gordon for ETF Expert makes the argument that diversification hasn’t been behaving in its traditional sense lately. In this modern day, ETFs of stocks, bonds, commodities, etc., all are tending to move in the same direction, just in varying degrees.

We agree with Gary’s assessment. At any given time, if someone were to look at one of our retired client’s portfolio, he or she might be amazed to see that 100% of it is invested in equity ETFs and 50% in foreign ETFs. We feel confident taking advantage of all the ETFs in various regions, sectors, commodities, large-caps, small-caps, etc., because we have a solid exit strategy. Whether diversification is pure or shifting away from its true form, trend following can adapt to either.    

It seems as if some ETFs are catching on this trend and have taken it into their own "hands" by using an actively-managed approach. This means they do some of the diversification for you by rotating their holdings. Some examples include:

• PowerShares DB G10 Currency ETF (DBV)
  DBV tracks currencies going long on the top three currencies and short on the lowest currencies.
• iPath CBOE S&P 500 BuyWrite Index ETN (BWV)
  Essentially, this ETN owns the stocks in the S&P 500 Index and then sells (writes) slight out-of-the-money S&P 500 Index call options, Gordon says.
• Claymore/Zacks Sector Rotation Fund (XRO)
  XRO rebalances its different sectors every quarter. Its holdings are pulled from 1,000 of the largest companies.
• Claymore/Zacks Country Rotation Fund (CRO)
  CRO comprises 200 stocks selected mostly from the MSCI EAFE Index that are rotated quarterly. Country allocations are made using quantitative macroeconomic factors with a bottom-up approach.

Tags: Bond ETFs, Currency ETFs, ETNs, Large-Cap, Sector ETFs, Small-Cap