ETFs are vital to meet the diversification challenge of a changing world

Investors today must grapple with a pace of change to the world economy and the markets which underpin it, which has never been seen before in human history. 

This change creates risks and opportunities that were inconceivable even a decade ago. Yet amidst this change, it remains diversification which offers us the best hope to deliver investors strong but consistent investment returns. 

What is clear, is that the diversification of yesterday will not alone provide the resilience portfolios need tomorrow. A broader range of asset classes is vital to ensure our investors are not left behind by a changing world.  

The simple government bond allocations that were previously relied upon for portfolio resilience have proven less able to weather recent shocks. Over 25 years, the 60 day rolling correlation between US equities and bonds has averaged −0.19, over the last five years it has flipped to a positive correlation of 0.16, and this year, in the face of a number of external shocks, it has peaked near +0.7. Bonds and equities have been moving together far more often than history suggests, and a portfolio built on that old relationship has proven less diversified than history implies. 

Source: Factset. Data to 16/10/2026 S&P 500 and US Aggregate bonds

This reality requires us to identify a broader range of portfolio diversifiers and to more precisely target the themes and factors within equity markets which are shaping the world.

In order to access these vital tools investors are increasingly turning to exchange-traded products (ETPs). The rapid growth of the market has allowed for the creation of a far richer range of products than were previously available to investors when portfolios were constrained to own mutual funds alone.

Many of the asset classes opened to us by ETPs have proven effective in just the sort of challenging environments when the historical negative correlation between shares and bonds has broken down. Commodities play a particularly vital role as they have the potential to thrive during environments where rapid change in the world produces bouts of unexpected inflation. For example, this unexpected inflation has been seen as a result of instability in the Middle East or unforeseen economic growth momentum from emergent technologies such as artificial intelligence.

Broader asset classes: Commodities are an effective hedge to unexpected inflation

Source: WisdomTree, Bloomberg Finance L.P, S&P. From January 1960 to March 2026. Calculations are based on monthly returns in USD. Broad commodities (Bloomberg commodity total return index) and US equities (S&P 500 gross total return index) data started in Jan 1960. US treasuries (Bloomberg US treasury total return unhedged USD index) and US corporate bonds (Bloomberg US corporate total return unhedged USD index) data started in Jan 1973. Historical performance is not an indication of future performance and any investments may go down in value.

The improved outcomes that ETPs offer are not just limited to the new asset classes they provide access to, but also extend to the precision with which investors can target specific exposures.

Although academic evidence has showcased that isolation of risk premia and factors is a vital tool for efficient portfolio management, it has remained difficult to target highly specific factors through UK mutual funds. In the world of ETFs, far greater factor-targeting precision is available. Of the strategic beta funds in our global universe 76% are ETFs and only 24% are open-ended mutual funds, giving investors a greater choice of factor exposures with the ETF wrapper.

Factors help us look beyond geographic boundaries to understand what drives equity returns. Companies listed in different markets can share similar economic sensitivities, while businesses within the same market can behave very differently. Identifying those relationships gives us a clearer view of where diversification exists and where apparently different holdings reinforce the same exposure.

Our investment approach must evolve alongside this expanding opportunity set. Factor research is central to that process, helping us refine how we identify and combine exposures as markets change. We draw on those insights to develop our factor strategies, with the aim of improving long-term outcomes for clients.

We put this research into practice through our new Core ETF Models, combining factor exposures within equities, commodities with different economic sensitivities, and thematic investments that target opportunities conventional allocations may capture only indirectly. Within fixed income, we select exposures that balance income, duration and credit risk across the portfolio.

The potential improvement in the efficient frontier comes from the interaction between these exposures. Adding a promising investment can enhance the portfolio, duplicate an existing position or increase its dependence on a particular market regime. We assess each allocation in that context, with a clear view of the contribution we expect it to make.

Source: Bloomberg/WisdomTree. Monthly data, gross of fees, 10-15 year estimated returns at 31/08/2026.

Historical performance is not an indication of future performance and any investments may go down in value.

Factor selection and a process that evolves

Factors have emerged over the past 50 years as the most evidentially-grounded means of understanding why some stocks rise more than others. Isolating them accurately involves understanding the sources of specific risk within specific companies and having a robust framework for isolating these traits in pursuit of higher returns. Geographic allocations alone can obscure meaningful differences in how companies behave and the risks they carry.

This makes it vital to look across markets through a factor lens, which we believe provides a stronger basis for diversification and the potential for enhanced risk-adjusted returns. We use ETFs to implement those views, with visibility into their methodologies and underlying holdings. This allows us to assess the intended factor exposure alongside the sector, regional and stock concentrations it brings to the portfolio.

This transparency means that when a fund is bought for its factor exposure, we can have confidence it actually expresses it. Historically, a factor ‘label’ on mutual funds has proven a poor guide to the actual exposure it provides. As ETFs typically take a more systematic approach, greater precision is possible. This point is made apparent in the two graphs below.

Source: Bloomberg. Data as at 16/10/2026

The distinction between a factor label and its implementation becomes particularly relevant when the opportunity set changes. For example, ‘Quality’ strategies built around different measures can produce materially different exposures, as shown above. We assess the attractiveness of each approach through the businesses selected, their pricing and the economic environment.

There is also a balance to strike between consistency and evolution. We want an allocation to retain the characteristics for which it was selected, while keeping our selection process open to new evidence. Wider adoption, changing corporate structures and shifts in market composition can affect the relevance of historical results.

We review how factor exposures are constructed and combined to understand their underlying drivers, diversification benefits and role within the portfolio. Our aim is a disciplined, repeatable process that can adapt as the opportunity set evolves.

Putting the wider opportunity set to work

Our goal is to extend the efficient frontier through the way we combine these exposures. We challenge the investment case across market environments, recognising that an attractive historical result is only the starting point. A new allocation earns its place through what it can add to the existing portfolio.

As the opportunity set develops, our research explores where structural change is creating investable growth and how best to capture it. The connections between themes are particularly interesting: growth in one industry can create demand, constraints and opportunities in another.

Some of the most compelling opportunities may lie beyond the obvious beneficiaries, in businesses and industries that conventional allocations overlook. Finding those opportunities and understanding how they can strengthen our portfolios and improve outcomes for clients is central to our investment approach.

This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.