A Portfolio for Volatility

08/12/2008 12:00 am EST

Focus: ETFS

Jim Lowell

Partner & Chief Investment Officer, Adviser Investments

Jim Lowell, editor, Forbes ETF Advisor, advises a bit of portfolio revarnishing to take advantage of the volatility.

Given that the SEC has put the kibosh on short selling financials—effectively confirming that shorting them was too smart a trade for the free market to bear—it makes sense to not fight the ban which, for us, means taking the lion share of our position in the ProShares Short Financials (AMEX: SEF) and looking for a better, near-term play on a field that isn’t rigged. (The fundamentals still support lower lows, despite the bailouts.) And while oil might come to mind, the fact that it has already posted a 15% correction based on nothing more than rumors of a global slowdown, doesn’t make it an easy sell in my book.

Given the potential for geopolitical impingements and Mother Nature’s wrath, not to mention political proclivities, I’d say we do short sell oil, but also hedge that bet in the following way: sell the ProShares Short Financials (AMEX: SEF), and place 2/3rds of the proceeds in the iShares Financial Services (PCX: IYG). Also, sell our existing stake in the PowerShares DB Agriculture (AMEX: DBA), and divide the proceeds between the ProShares Short Oil & Gas (AMEX: DDG) and the Claymore Global Timber (AMEX: CUT).

The ProShares Short Oil & Gas ETF seeks results that correspond to the inverse performance of the Dow Jones US Oil & Gas Index; for example, if the DJ US Oil & Gas index returns -2%, DDG will return +2%. The index measures the performance of the energy sector of the US market. The top ten holdings in the index are Exxon Mobil, Chevron, ConocoPhillips, Schlumberger, Occidental Petroleum, Devon Energy, Transocean, Halliburton, Apache, and Marathon Oil. DDG began trading in June 2008. It has an average daily trading volume of over 5,000 shares and carries an expense ratio of 0.95%.

I also recommend buying Diamonds (AMEX: DIA), which is designed to represent the performance of the Dow Jones Industrial Average (DJIA), the venerable blue chip benchmark, the Fidelity NASDAQ Comp Index (Nasdaq: ONEQ) that replicates NASDAQ, and the iShares MSCI Japan (PCX: EWJ), which is designed to represent performance of the Japanese equity markets biased, to the larger cap names at its top. Japan is not only the world’s second largest economy (despite an epic recession which would have crushed many economies into non-existence), it’s a recovering and growing one which not only stands at the gateway to China, but as the gateway to it.

For investors seeking growth and income, the iShares DJ US Total Market Index (PCX: IYY) is a broad-based index representative of the total market for US equity and the iShares Lehman Aggregate Bond (PCX: AGG) benchmarks to the Lehman Brothers US Aggregate Index, representing the total US investment grade bond market.

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