Exchange traded fund investors should keep up with the ever-changing market conditions to hedge portfolio positions and diversify risk exposure.
Many long-term investors are content with just diversifying their portfolios with broad non-correlated assets to manage risk in traditional equities and fixed-income positions. However, quick market turns could could create problems in the short-term.
“Interactions and correlations between asset classes and market risks can change suddenly,” writes Euan Munro, chief executive of Aviva Investors, for Financial Times.
For instance, Munro points out that the credit and equity markets, along with interest rates, have seen correlation rise in the wake of quantitative easing, and he believes that the link between the two asset classes will change again when QE is toned down.
Additionally, Munro argues that investors should monitor their overall exposure to the markets, instead of just breaking it down to equity and fixed-income assets. For instance, investors may be overexposed to the corporate sector since a typical portfolio may include equities and broad fixed-income, which also includes corporate bonds. Both stocks and corporate debt are issued by companies, so investors may be underexposed to safer government debt.
Among broad diversified bond ETFs, the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG) includes 13.6% industrial and 6.9% financial institutions, and the Vanguard Total Bond Market ETF (NYSEArca: BND) holds 8.9% finance and 16.1% industrial.
“What might look like a well-diversified portfolio could be nothing of the sort,” Munro added.