An interesting question has recently been brought up as to whether or not emerging market exchange traded funds (ETFs) truly help diversify one’s portfolio.

Gary Gordon of ETF Expert points out that this depends on how one defines diversification. If investors are looking to reduce market risk by meshing assets that do not tend to move in the same direction, their investments must have little relationship, if any at all. Or, if one is looking to invest in a number of stock assets with differing degrees of upside potential and downside volatility, then the issue is not price direction.

Since all stock assets tend to move in the same direction, most investors are not really diversifying by purchasing different companies and different sotck funds.

Over the last few years, there has been increased discussion and investment in foreign markets. This arose from the idea that foreign stocks could move independently of the US stock market. However, as the current market environment reveals, the U.S. market has affected nearly every other stock market worldwide. These market trends reveal that emerging markets have a higher correlation to U.S. indices, such as the S&P 500, than originally thought.

As the economy is still experiencing a bear market, it is essential to make sure that one’s portfolio is truly diversified. To ensure solid diversification, Gordon recommends that a portfolio has assets with less than a 0.5 correlation to the S&P 500. Even better, he encourages investors to consider assets with a zero correlation. Finally, he recommends some negatively correlated assets, or those that move in the opposite direction of the S&P 500.

Among the suggestions include:

  • Dow Jones Total Commodity Index (DJP), up 11.3% year-to-date
  • Wisdom Tree Emerging Market High Yield Fund (DEM), down 0.1% year-to-date

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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