Many alternative methodologies tilt towards value, and I imagine that many investors believe this value tilt will help them if the market turns sour. But value stocks have outperformed growth stocks for many years now, and there is a lot of money tied up in "value" strategies. It's not clear that value will have the same protective qualities in the future that it had in the past.
Critics of this position will argue that the stocks that make up "value" are always changing, so that the relative "value-ness" of the asset class doesn't really change over time. I'm not sure that's true anymore. In the past, "value" indexes used simple measures to divide stocks into growth and value: the S&P indexes, for instance, used price-to-book value as the sole determining factor. But over the past few years, indexers have changed their methodologies, putting a much greater emphasis on price-to-earnings ratios and forecast earnings growth. As such, value indexes are holding different stocks, and the performance of the indexes may have changed.
Two: To Diversify, Stick With Different Asset Classes
If you want diversification, stick to alternative asset classes: bonds, commodities, etc. Alternatively weighted ETFs do perform differently from market-cap weighted indexes, but not that differently. The PowerShares RAFI 1000 ETF, for instance, trailed the SPDR by 18 basis points, while the WisdomTree Large Cap Dividend ETF beat it by 21 basis points: small potatoes during a 5 percent market turndown. Meanwhile, the iShares Lehman Aggregate ETF (fixed income) beat the SPDR by 5.5 percent, and the PowerShares DB Commodity Index won by 1.9 percent: much, much bigger differences.
Three: Gold Is Funky
In the past, gold was the first place investors turned when the market looked nervous. But look what happened during the February/March downtown: gold fell by 7.59 percent, or 2.2 percent more than the index. What gives? I'm not entirely sure.
Gold has come detached from inflation expectations, and is running on a different trend pattern. Some see it as a catastrophe hedge, and argue that the troubles in Iraq led to the strong run-up in gold. I have a feeling that there's a momentum issue here: gold ran up after the Internet bubble as investors looked for "the opposite of stock." As it moved, it attracted new investors, who poured money into the commodity: the streetTRACKS Gold ETF (AMEX: GLD) recently topped $10 billion in assets.
Gold's sharp pullback during the recent market contraction confirms my suspicion that momentum players are driving the price.
Four: International May Lead The Way … Down
Investors looking for diversification away from U.S. equities have in the past turned to international stocks. But as a smart advisor said to me the other day, "International has become a high beta version of the U.S.; the correlations are tightening." Note, for instance, that the iShares MSCI EAFE ETF actually led the SPDR down, trailing the U.S. by 2.2 percent. The only international market that really held up well during the market meltdown was Japan, which is at a different place in its economic cycle.