Looking to smooth out volatility in your portfolio? Keep an eye out for Compass EMP Funds, because these guys are pushing for a new approach to investing: Alternatives.
For Compass, whose U.S. Large Cap 500 Volatility Weighted Index outperformed the S&P 500 seven times over since Sept. 30, 2000, says it's all about alternative investments. Their approach is to invest in all global asset classes, equally weighted and rebalanced by volatility.
Wait what? Let me explain
U.S. stocks, bonds and exchange-traded funds represent a small class of investment opportunities. And sure, they often do well, but their performances year over year can pale in comparison to alternative assets such as commodities, real estate (U.S. and international REITS), managed futures, and fixed income (U.S. and international bonds).
Every year some fare better than others, but if someone was equally invested in all asset classes (weighted by risk), the average performance is typically much higher than just the stock market. For example, under this approach, the 10-year equal weighted annualized return is 6.74%. The S&P 500 average 10-year return is 2.92%.
To be fair, it's a complex game -- and no one should enter into the alternatives markets without some knowledge and a bit of experience under his or her belt. Education is key -- investors really need to focus on how to compare one asset versus another -- and Compass EMP is ready to step in.
Here's how: Diversification in personal portfolios
Compass points out that "big boy" investors, those with more than $1 billion in their portfolio, have an average 11% weight in U.S. stocks and a 60% in alternatives. Meanwhile, the smaller under $25 million crowd is heavily invested in U.S. stocks at 40%, and alternatives at 12% (the rest is made up by international stocks, fixed income, and cash equivalent holdings). And let's face it: Big investors do their homework when deciding where to put their millions. The returns are worth the time.
But since most of us fit into that "under $25 million" category, and are just a one-man show, we have to wonder what the best method of diversification is with the tools at hand.
Stephen Hammers, managing partner, co-founder, and CIO of Compass EMP, says ETFs with sector or multisector coverage are a good start: "You can take volatility by sector. You'll end up with a bit more utilities and less tech, but you'll have to adjust to make sure all the industry coverage is the same -- what you end up doing is equalizing volatility between sectors and provide smoother returns."
ETFs are broad in nature, do your research to discover new ways of gaining exposure to a variety of investment classes.
To measure weight by volatility, simply compare the stocks on a graph over the past 180 days, and note their standard deviation from the average mean (Kapitall's Turbo-Charts can help you do exactly this). By definition, the higher the deviation, the higher the risk.
Diversify within equity markets
Hammers says that within equities health care, tech, and financial sectors offer the most growth opportunity. But be careful, he warns, "Investors need to understand we're on the cliff and have been there for a while. Budget deficits, spending and debt are out of control. It's one of the reasons why U.S. growth isn't expanding the way it should in a post-recession, and Europe is in a far worse state."
He adds that the market rally had a lot to do with good news and optimism, "but nothing really changed. Our economic growth has not really excelled." Essentially, proceed with caution, and don't place all your funds into equities if you're looking for smooth growth.
Business section: investing ideas
"Investing in alternatives is an educational process. We brought product and methodology to the table," says David Moore, speaking about his funds. Or, he adds, forget the legwork and just invest with their mutual fund. Fair enough.
But for those looking to stick with equities, Compass is still able to offer direction through their CEMP U.S. Large Cap 500 Volatility Weighted Index. It's a universe of the 500 largest U.S. common stocks with positive EPS in the past four consecutive quarters, which are then weighted based on their daily standard deviation over the last 180 days compared to the aggregate mean.
As mentioned before, a 148.01% return since Sept. 30, 2000, says a lot to recommend this strategy.
Here are the top and bottom 10 holding and their index weight based on volatility. Data as of March 31, 2012. (Click here to access free, interactive tools to analyze these ideas.)
1. Southern Co.: Operates as a utility company that provides electric service in the southeastern United States. Market cap at $40.11B, most recent closing price at $45.97. Index weight 0.47%.
2. Kimberly-Clark (NYSE: KMB ) : Engages in the manufacture and marketing of health care products worldwide. Market cap at $30.79B, most recent closing price at $77.92. Index weight 0.44%.
3. Procter & Gamble: Provides consumer packaged goods in the United States and internationally. Market cap at $175.1B, most recent closing price at $63.77. Index weight 0.42%.
4. General Mills: Manufactures and markets branded consumer foods worldwide. Market cap at $25.2B, most recent closing price at $38.91. Index weight 0.41%.
5. Energy Transfer Equity: For its acquisition of Southern Union Co., which was engaged in the gathering, processing, transportation, storage, and distribution of natural gas in the United States. Index weight 0.41%.
6. Kraft Foods (NYSE: KFT ) : Together with its subsidiaries, manufactures and markets packaged food products worldwide. Market cap at $70.46B, most recent closing price at $39.72. Index weight 0.39%.
7. Hershey Co.: Engages in manufacturing, marketing, selling, and distributing various chocolate and confectionery products, pantry items, and gum and mint refreshment products worldwide. Market cap at $15.01B, most recent closing price at $66.69. Index weight 0.38%.
8. Duke Energy: Operates as an energy company in the Americas. Market cap at $28.81B, most recent closing price at $21.43. Index weight 0.38%.
9. Johnson & Johnson: Engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Market cap at $179.36B, most recent closing price at $65.14. Index weight 0.38%.
10. McDonald's: Operates as a foodservice retailer worldwide. Market cap at $98.77B, most recent closing price at $97.28. Index weight 0.38%.
Bottom 10 holdings
1. Green Mountain Coffee Roasters (Nasdaq: GMCR ) : Engages in the specialty coffee and coffeemaker business. Market cap at $7.7B, most recent closing price at $49.76. Index weight 0.07%.
2. Netflix (Nasdaq: NFLX ) : Provides subscription based Internet services for TV shows and movies in the United States and internationally. Market cap at $4.52B, most recent closing price at $80.45. Index weight 0.08%.
3. Illumina: Develops, manufactures, and markets integrated systems for the analysis of genetic variation and biological function. Market cap at $5.62B, most recent closing price at $45.56. Index weight 0.08%.
4. MetroPCS Communications: A wireless telecommunications carrier, together with its subsidiaries, provides wireless broadband mobile services in the United States. Market cap at $2.56B, most recent closing price at $7.03. Index weight 0.09%.
5. Walter Energy (NYSE: WLT ) : Produces and exports metallurgical coal for the steel industry primarily in the United States. Market cap at $4.14B, most recent closing price at $64.54. Index weight 0.09%.
6. Riverbed Technology: Provides solutions to the fundamental problems associated with information technology performance across wide area networks in the United States and internationally. Market cap at $3.15B, most recent closing price at $19.51. Index weight 0.09%.
7. Cree: Develops and manufactures light emitting diode products, silicon carbide and gallium nitride material products, and power and radio frequency products. Market cap at $3.66B, most recent closing price at $31.17. Index weight 0.1%.
8. Polycom: A provider of unified communications solutions and a provider of telepresence, video, voice and infrastructure solutions based on open standards. Market cap at $2.31B, most recent closing price at $12.97. Index weight 0.1%.
9. Jefferies Group: Operates as a securities and investment banking company in the Americas, Europe, and Asia. Market cap at $3.28B, most recent closing price at $15.72. Index weight 0.11%.
10. Citigroup: Provides consumers, corporations, governments, and institutions with a range of financial products and services. Market cap at $98.47B, most recent closing price at $33.13. Index weight 0.11%.
Interactive chart: Press play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.