Portfolio Protection With ETFs

By Gregory S. Davis | June 26, 2008 AAA

One of the best ways for investors to lower volatility in their portfolios is to add non-correlated assets. In this article we'll examine several exchange-traded funds (ETFs) that have performed well during the recent stock market correction and could help take some risk out of an under diversified portfolio. (For an introduction to what ETFs can do for you, check out our ETF Special feature.)

Treasury Inflation Protected Securities
The iShares Lehman TIPS Bond (NYSE:TIP) is designed to take the inflation bite out of a portfolio by focusing on U.S. Treasury Bonds and Notes. The goal of the TIP fund is to offer investors inflation protection.

Commodity Index
The PowerShares DB Commodity Index Tracking Fund (AMEX:DBC) holds a basket of futures contracts for Crude Oil, Heating Oil, Corn, Aluminum, Wheat and Gold. For investors who would like exposure to silver they may consider adding PowerShares DB Precious Metals Fund (AMEX:DBP) which is composed of 85% Gold futures and 22% Silver Futures. Yes, that does not add up to 100% suggesting that DBP uses some leverage to boost performance.

Steel Focus
Construction will not be going out of style anytime soon, making steel a worthy addition to our protection portfolio. Market Vectors Steel ETF (AMEX:SLX) is composed of 28 stocks in the steel industry. Its top three holdings include Rio Tinto PLC (NYSE:RTP) and Companhia Vale Do Rio Doce (NYSE:RIO), two of the world's largest iron ore miners, along with ArcelorMittal (NYSE:MT), one of the world's largest steel companies.

Base Metals
The PowerShares DB Base Metals ETF (AMEX:DBB) gives you exposure to copper, zinc and aluminum. The three base metals are almost equally weighted in the ETF with copper making up the largest percentage. Each of these metals fits in with the global infrastructure theme.

Agriculture
The PowerShares DB Agriculture ETF (AMEX:DBA) gives you sugar, soybeans and corn as its top three holdings followed by wheat futures. Increased consumption of meat in emerging markets, the increased use of corn for biofuels and weather related disruptions of food crops could continue to put pressure on these agriculture commodities. (For more on wheat futures, check out Grow Your Finances In The Grain Market.)

Natural Gas
The United States Natural Gas ETF (AMEX:UNG) is mentioned last because it may be the equivalent of recommending China a year ago before its index pulled back this year. Natural gas has had a tremendous run, but an investment in this direction would be better served when prices cool off.

Conclusion
Global trends including an increasing population and emerging market development suggest that the commodities ride is not over, but investors should remember it's always better to leave the dance floor before the music stops. The ETFs mentioned, depending on your risk tolerance, could make up 5% to 10% of your portfolio. Investors must take time to research and find investments that will float when the rest of their portfolio is sinking.

For an alternative ETF strategy, check out Rebound Quickly With Leveraged ETFs.

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