Investors' tolerance for risk seems to be on the rise, as they watch U.S. equities markets rally to multiyear highs, but that doesn't mean that asset allocation isn't more important than ever. In fact, Jonathan Citrin, head of Citrin Group, a Birmingham, Mich.-based registered investment advisor, told IndexUniverse Correspondent Cinthia Murphy that his firm has brought asset allocation to an entirely new level.

With correlations on the rise in the risk-on/risk-off markets that characterize the post-crash world, true diversification can only be found in the unexpected pockets of the market that ETFs have opened up to all investors in the past generation.

Murphy: You have built a business that relies solely on ETFs to manage client assets.

Citrin: I’m an ETF-based advisor. We are an ETF-only shop. I’ve been indexing since the early 2000s-2001, during the times of the triple “Q’s” SPDRs and little else. I’ve found a niche in what I call true academic asset allocation. A lot of people use “asset allocation” as a generic term, but getting it right is hugely important. The way we do it is through two portfolios—a growth portfolio and a fixed-income portfolio—and every one of our clients has some configuration of both. We manage $55 million in assets.

Murphy: What do you mean by “true asset allocation” as opposed to “generic”?

Citrin: During the tech bubble, it really struck me how people went nuts throwing money at tech stocks, chasing what were the hot stocks at the time. A lot of people chase returns, but they use the term “asset allocation” to mean diversification, but that’s only true on the surface.

One of my favorite examples of this is REITs. You hear a lot of people talking about REITs as a diversifier—they think of it as investing in real estate—but REITs are publicly traded companies that are just as susceptible to systemic risk as other equities. It’s easy to diversify idiosyncratic risk, but it takes true asset allocation to minimize exposure to systemic risk.

Murphy: Is this a problem of overlooking correlation among asset classes?

Citrin: Professionals use the term “asset allocation” broadly, but they don’t necessarily look at underlying correlations to see if the allocation is really something that will hold up. Some think that to have U.S. and international equities, REITs and bonds means your portfolio is diversified. But that’s diversification only on the surface. To truly have asset allocation, you have to do it from a mathematical perspective rather than from an emotional one. That was part of the problem in 2008: Investors were not truly diversified, and the assets they had for diversification quickly turned illiquid.

If I look at a portfolio and everything is up, I’m not happy. That means something is wrong and I’m not really diversified. People run towards what’s up and away from what’s down. I run to what’s low—buy low, sell high. The dollar, for instance, is one of my favorite diversifiers right now. It’s down and a lot of people have told me I should get out of the dollar, but it’s a good diversifier.

And I’ll tell you that ETFs have enabled us to continue to add diverse areas of exposure for clients in a way that was not possible before.

Murphy: So you think that correlations among asset classes is on the rise and ETFs are helping fuel that trend?

Citrin: Gold is a great example of a diversification tool that no longer works the way it once did. Gold has always been used as a hedge against inflation, as protection from market swings, but I fear that as ETFs make these assets more and more accessible, and they start to trade so much more, they become more correlated to other assets such as equities. The diversification potential drops, and that’s the challenge we advisors face: to be constantly looking for new ETFs and new ways to diversify.

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