Do ETFs Provide Cheap Diversification For Risky Times?
- Investors can mitigate risk with ETFs that spread assets around, Morningstar says.
- Diversification may work for investors who get queasy as the market gyrates.
- Complacency about risk may be high despite worries about recession or worse.
Investors can be forgiven for buying the dips, as they have continued to do even as markets whirl from an unprecedented trade war—a largely unwelcome contest whose end hasn’t yet come into view.
In the past, markets have reliably bounced back after massive drops, such as the dot.com bubble 25 years ago, the 2008 financial crisis and the 2020 Covid-19 shutdown.
An investor who placed $10,000 in the SPDR S&P 500 ETF Trust (SPY) when it launched in 1993, riding out market declines, has $127,000 today. Still, that’s about $10,000 less than this investor had at January’s close, and no one can predict if more losses or gains are coming.
With a supposedly pro-business White House and markets’ record of bouncing back, are investors sleepwalking when it comes to risk?
ETFs Offer Simple, Cheap Diversification
The World Trade Organization on Wednesday cut its global growth outlook thanks to reduced trade, and investing guru Ray Dalio recently said "something worse than a recession" may be on its way.
Still, $31 billion has been put into the iShares Core S&P 500 ETF (IVV), the world’s third-largest ETF, over the past month as equities maintain their appeal.
Source: etf.com data
Those seeking to mitigate risk might consider spreading it around. ETFs were pretty much created to offer cheap, simple diversification, which may be the right strategy now to reduce risk.
“There’s no time like the present to pay risk its due respect by diversifying portfolios to handle whatever may come next, good or bad,” Morningstar analyst Bryan Armour wrote in a research note April 16. Diversification is the only free lunch in investing, he added, enhancing long-term holdings as it “sidesteps the pitfalls of bad luck.”
Three ETF Baskets for Diversification
Diversifying stock portfolios largely means putting your eggs in several baskets: bonds, stores of value and liquid alternatives.
For bonds, Armour called out the iShares Core US Aggregate Bond ETF (AGG) and the iShares US Treasury Bond ETF (GOVT). Investors aren’t heeding that tip at the moment since they’ve pulled $1.8 billion from AGG and $1.3 billion from GOVT over the past month.
Gold is his store of value recommendation, and one that many investors are grabbing onto. The SPDR Gold MiniShares (GLDM) is a top bet, he wrote. GLDM has gained 8.3% over the past month while investors poured in a net $1.2 billion.
In the liquid alternatives category, he recommended managed futures strategies “because of their ability to go long or short asset classes and hedge against down-trending markets.” The iMGP DBi Managed Futures Strategy ETF (DBMF) is his choice there. That fund is little changed over the past month, with inflows and outflows largely cancelling each other out.
