These ETFs Hit All The Right Diversification Buttons

November 02, 2016

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Rusty Vanneman, chief investment officer of Omaha, Nebraska-based CLS Investments.

The U.S. stock market, at least defined by the large companies in the Standard & Poor’s 500 Index, is at an all-time high. It’s been an incredible bull market—extending its streak as one of the longest and strongest in U.S. stock market history.

While U.S. large-caps have had a nice run, and in turn their valuations have gotten stretched, not all markets have participated in the strong gains and became over-valued. Some markets are still well off their all-time highs.

At the end of August, for example, emerging market equities (MSCI Emerging Markets Index) were still 20% below their highest point. Commodities (Bloomberg Commodity Index), meanwhile, were more than 60% below their peak.

One Diversification Button

For investors—particularly those with heavy allocations to large, domestic companies—where is a good place to diversify and increase exposure? The answer is an investment that can hit all these buttons:

  • Alternatives: By providing a quirky, lower-correlation (behaves differently from the U.S. stock market) asset.
  • Commodity: Because commodity markets appear to be emerging from one of their sharpest, deepest bear markets ever.
  • Low Volatility: Because of the aforementioned diversification benefits of a lower correlation, it can help reduce overall portfolio volatility.
  • Contrarian: Many investors have decreased their exposure to this asset class in recent years due to poor performance.

In addition, this investment has the following benefits:

  • It takes advantage of emerging market economic demand.
  • It should be aided by rising inflation, which has been creeping higher lately.
  • It should see plusses from climate change.
  • It should help investors make money. Valuations relative to the overall market are at some of their most attractive levels in years.

Those are a lot of buttons and benefits, and they are the reasons we’re increasing allocations to this asset class. We are talking about commodity-producer equities (or natural resource equities).


Natural Resource Equity ETFs

There are some excellent, broad-based commodity-producer equity ETFs available to invest in this idea:

Each ETF has merits, but let’s look at the largest of the three. The FlexShares Morningstar Global Upstream Natural Resources (GUNR) has the most trading volume and, as of this writing, the best performance so far this year.

GUNR is unique to other commodity-producer ETFs in a few ways.

First, with its emphasis on upstream (closest to a resource’s location in the ground), GUNR is designed to give investors access to global equity securities. It emphasizes the start of a resource’s supply chain, which should enable it to more fully participate in the rising global demand for natural resources. It is seeking to capture this favorable growth and the price impacts of this trend.

Second, while GUNR emphasizes the basic materials and energy sectors, similarly to other commodity-producer ETFs, it also emphasizes the agricultural sector while maintaining exposure to the water and timber sectors. The ETF’s methodology seeks to prevent any one area of natural resources from dominating or skewing overall exposures or performance.

With this approach, the results have been attractive so far. And moving ahead, given all the buttons this ETF (as well as GNR and IGE) hits, we expect a strong contribution to our portfolio’s long-term, risk-adjusted performance.

At the time of this writing, CLS Investments invests in GUNR and GNR for its clients. CLS Investments is a third-party investment manager and ETF strategist. It began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds. Contact CLS’ Chief Strategist Scott Kubie at 402-896-7406 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions.


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