Table 2 repeats the process using ETFs based on the Dow Jones US index and the Dow Jones industrial average (IYY and DDM). In this table, the ETFs are expanded to include currencies, U.S. Treasury securities, Asian markets, small cap stocks, as well as three sectors: financials, utilities and technology. The selection is also expanded to include ETFs that take short positions in U.S. Treasuries (TBT) and short positions in stocks (RWM for the Russell 2000 index, SKF for financials, SDP for utilities and REW for technology).

The coefficients in Table 2 duplicate the results from Table 1. The Asian markets, small caps and long sector ETFs are highly correlated to the aggregate market. The short ETFs (FPX, RWM, SDP and REW) are highly negatively correlated to the aggregate market; these ETFs virtually mirror the comparable long ETFs. For example, the correlation for the long ProShares ETF (UGY) and the aggregate market is 0.906. For the short ETF (SKF), the coefficient is -0.876. Adding the short ETFs should contribute to diversification.

Tables 3 though 5 report the coefficients between precious metals, real estate investment trusts, currencies and the other ETFs. While the precious metal ETFs are highly correlated among themselves, little correlation exists between the precious metal ETFs and the other ETFs. While the returns on the various REIT ETFs are positive (Table 4), the coefficients do suggest that adding a REIT ETF to an aggregate portfolio contributes to diversification. Even though the correlation coefficients between the REIT ETFs and the other ETFs generally exceed 0.5, they are lower than the coefficients between the aggregate markets and the various sectors.

The coefficients for currencies and the selected ETFs in Table 5 suggest that adding currencies also contributes to diversification. While the majority of the coefficients are positive, the numerical values are small (i.e., less than 0.4) and in some cases are negative. For example, one ETF based on the Japanese yen (FXY) is negatively correlated with the ETFs for small-cap stocks, utilities and technology stocks.

The results reported in Tables 1 through 5 are limited by the short period during which many ETFs have existed and by the return data being generated primarily during a period to declining stock prices. The results of the correlation coefficients relating returns on aggregate market ETFs and more specialized ETFs, however, do suggest the potential for diversification. The results also highlight that the investor needs to be selective in the choice of which ETFs to include if the objective is to diversify the portfolio.

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