Diversification among the stand-by asset classes (60/40 stocks/bonds) is not what it used to be. In fact, the use of additional "diversifiers" like gold hasn’t been extremely helpful either.
What do I mean?
In the 21st century, all assets have been moving higher or lower together. If stocks, bonds, currencies and commodities all tend to move in one direction… and the only difference tends to be the amount of perceived risk associated with the asset class itself… then you are no longer able to get true diversification.
The idea of diversification, of course, meant that some of your positions go up when others go down. Now it’s just a matter of degree.
So what can you do? What should you do? Some suggest that the only thing that can be done is tempering risk with higher cash allocations. It may be the only true non-correlated asset left. However, others see value in using "strategy funds" as a means to diversify.
Perhaps one alternative is the use of the PowerShares DB G10 Currency ETF (DBV). The fund gives individual investors the opportunity to profit form the popular yen-carry trade (i.e., selling currencies with low yields while buying currencies with higher yields.)
Here you have an investment that, theoretically, changes when the yields of currencies are changing. You get the opportunity to short the yen when the yen offers little in the way of interest and you get to own the Australian dollar when the interest is high. And you only need one ETF wrapper to implement the approach.
Another alternative is the use of the "covered call" strategy.The iPath CBOE S&P 500 BuyWrite Index ETN (BWV) seeks to replicate the total rate of return of a hypothetical “covered call” approach with the S&P 500 Index, minus expenses. In essence, the fund owns the stocks in the S&P 500 Index and then sells (writes) slightly out-of-the-money S&P 500 Index call options. Option selling works quit well for many long-term investors.
So how are these strategic investments working as diversifiers? Not so well in recent months, though neither strategic alternative has been around long enough to evaluate fairly.
Historically, the indexes tracked by these exchange-traded products (DBV, BWV) suggest better diversification than one might get from more traditional sources alone (e.g., stocks, bonds, commodities, etc.). Yet in 2007, it seems that people flee risk… any risk… by the droves. And that makes cash the true king.