How can I find a high-risk, high-reward investment that is not strongly correlated with the U.S. economy?

Question

I'm looking to add something to my investment portfolio for diversification. Right now, I own mostly a U.S. stock index fund, with a little bit of an international stock index fund, bonds and cash for diversification. I'm looking for something with the following attributes:

1. High-risk, high-reward, comparable to a diversified stock portfolio or maybe even riskier. It seems like anything considered safe is yielding practically nothing nowadays, and I have a long enough time horizon to tolerate some risk if it can be justified by higher expected returns and better diversification.

2. Generally performs well over long time horizons if you buy-and-hold.

3. Not strongly correlated to the health of the U.S. economy. Will not tend to rise and fall at the same time as broadly diversified stock portfolios. International stock is becoming less and less useful for this because as the economy becomes more globalized, U.S. and international stock tend to rise and fall at the same time.

4. Not gold. I think gold is a bubble and wouldn't touch it with a 10 foot pole at these prices.

How can I go about discovering an investment that meets my criteria?

Answer 1

High risk, high reward doesn't really mean anything. The reason that investments are risky is that the investor is clueless. As you gain more information and experience, you reduce the risk.

To answer your question, you can consider BRIC ETF's (Brazil, Russia, India and China). They are correlated to the U.S. economy. However, over the long term (say, 40 years), they may make sense. It depends on your outlook. Do you think India and China will have bigger economies in than the U.S. in 40 years? Many people do. Do you think that countries that are rich in commodity resources like oil will do well in the next 5 years? If so, then those countries may do better than the U.S.

It's not a clear answer to your question, but maybe it can help lead to a good solution for you.

Answer 2

These days almost all risky assets move together, so the most difficult criterion to match from your 4 will be "not strongly correlated to the U.S. economy." However, depending on how you define "strongly," you may want to consider the following:

• FX Emerging Market carry trade (I believe some ETFs or mutual funds make this trade available to retail traders, or you can do it yourself with a retail FX broker)
• Emerging Market government bonds (If you want risk, stick to the less popular ones, like Venezuela, Argentina, Lebanon, Turkey, or just invest in a broad index ETF like EMB)
• International REITs (e.g. VNQI, but direct investments will be more uncorrelated if you have the minimum capital required)
• Farmland/timberland (note: may currently be very overvalued)
• Commodity Trading Advisor (CTA) funds

Be careful, you are sort of asking for the impossible here, so these will all be caveat emptor type assets.

EDIT: A recent WSJ article talks about what some professional investors are doing to find uncorrelated bets.

Alfredo Viegas, an emerging-markets strategist for boutique brokerage Knight Capital Group, is encouraging clients to bet against Israeli bonds. His theory: Investors are so focused on Europe that they are misjudging risks in the Middle East, such as a flare-up in relations between Israel and Iran, or greater conflict in Egypt and Syria.

Once they wake up to those risks, Israeli bonds are likely to tumble, Mr. Viegas reasons. In the meantime, the investment isn't likely to be pushed one way or another by the European crisis, he says.

Answer 3

It requires fairly large levels of capital, but what about seed funding/angel investments in startups? This would be before venture capital gets involved, so the amounts are relatively low (tens of thousands, vs. millions of USD), but as valuations this early in the game are also low, you can get a significant portion of equity in a startup that you feel is being run by good people and is in a promising market. Paul Graham of Y-Combinator has a number of articles about this from both sides of the table that you can take a look at and see if this is for you. It's definitely very high-risk, but if you can pick successful startups before their valuation shoots up, get some equity, help them succeed, and they eventually go public or get acquired, you can stand to bring in some big returns.

Note that this isn't a hands-off investment. You'll need to build connections in the startup community, and it isn't uncommon for angel investors to become involved in the day-to-day operations of the businesses in which they invest.