The narrative on Wall Street during the past few months has been one of volatility and uncertainty. The popular momentum trades of the year — including hot emerging markets or the Nikkei/Yen trade — have lost steam in a hurry.
So what’s next as we look for new leadership? Well, it’s hard to tell. It could be U.S. megacaps as the market gets defensive after front-loaded returns. If the global economy rounds the bend, it could be the battered markets of Europe. Or it could be some corner of Wall Street that we aren’t even watching yet.
With such a cloudy outlook, then, it behooves investors to start thinking longer-term and lower-risk. And the easiest way to take on that kind of strategy is to buy diversified ETFs that fit well with the current headlines and that will be resilient against just about anything the market will throw our way.
To help you rebalance your portfolio for the second half of 2013 and beyond, here are five ETFs that investors should consider staking out a position in right now:
iShares Nasdaq Biotechnology Index Fund
The iShares NASDAQ Biotechnology Index Fund (IBB) is a great way to both play upstart drugmakers and get exposure to bigger players for some stability.
For instance, the top three IBB holdings as of June 19 are Regeneron (REGN), Gilead Sciences (GILD) and Amgen (AMGN) — a trifecta worth about $175 billion. These are hardly up-and-coming players, with all running very profitable operations and no risk of going to zero on one bad drug trial. However, it also has a stake in smaller players that will break out, like Isis Pharmaceuticals (ISIS), which has more than doubled since Jan. 1.
All told, the IBB fund is up an impressive 26% year-to-date — almost double the S&P 500 — and is up about 36% in the last 12 months.
Given the demographic pressured fueling healthcare generally — driven by aging baby boomers — and the specific potential of niche drugs and breakthrough medical technology, all investors should look to this sector for growth. And given that healthcare also is a (mostly) recession-proof sector, any downturn shouldn’t hit IBB too badly in the months ahead.
With almost $3.1 billion in assets and a six-digit daily trading volume, this is a legit and liquid fund. IBB will cost you 0.48% in expenses (that’s $48 in fees annually for $10,000 invested).
If you’re looking to stake out a claim in the recovery, financial stocks are a very good bet right now. Thus, the Financial SPDR (XLF) should be on your radar during the second half of 2013.
Why? For starters, financial stocks are inherently cyclical in nature; they do best when the economy is humming along, which causes investment and lending to hum along, too.
Also, the fundamentals still are cheap. Compared with other sectors, banks remain undervalued based on forward earnings. Investors have been discounting bank shares since the financial crisis for obvious reasons, but this can’t last forever.
Also remember that dividends have remained pretty anemic in the sector thanks to the red tape of the Federal Reserve “stress tests,” so there’s the potential for payouts to move up significantly in the years ahead. Consider that Bank of America (BAC) and Citigroup (C) pay a nominal penny per quarter on each share of stock. That can and will move upward.
There is the risk that a downturn could hurt banks, of course, but the XLF is focused on major financial institutions and shouldn’t see the same risk as regionals or smaller banks. After all, there have been many complaints about “too big to fail” … but the hard truth is that major financials cannot and will not be allowed to collapse no matter what happens in the next few years. That’s just the way it is.
With a very low expense ratio of 0.18%, or just $18 on $10,000 invested, this is a great way to play the sector.
Vanguard Energy ETF
Another cyclical play — this time with an eye toward inflationary pressures that might take hold in 2014 or beyond — is the Vanguard Energy ETF (VDE).
With top holdings in megacaps like Exxon Mobil (XOM) and Chevron (CVX), investors can be confident in the stability of this fund should the market run into trouble. They all pay decent dividends, too, and will provide a bit of income.
The energy sector provides some pop longer-term for folks betting on a recovery improving demand for fossil fuels, as well as those expecting high federal deficits and the chance of a weaker dollar in 2014 to boost inflation. Right now inflation is handily under control, but farther down the road it could be a problem and result in rising crude oil prices — and thus profits across the energy sector rising in kind.
Total assets of VDE top $2.6 billion and the expense ratio — like always in Vanguard’s family of funds — is very low. This energy ETF charges just 0.14% in expenses, or $14 per $10,000 invested.
Vanguard S&P 500 ETF
It’s not sexy, I know — buy the S&P 500 and forget it. But all the commentary out there indicates that passive indexing with low-cost ETFs is a powerful long-term investment strategy, and is the right move for most people right now.
If you’re looking to simply buy the market broadly and keep your costs down, you can’t do much better than the Vanguard S&P 500 ETF (VOO). With expenses of about 0.05%, or just $5 for every $10,000 you invest, this is a remarkably cost-effective way to play stocks.
You also have the defensive strategy of diversification baked in, distributing your money across the entire S&P 500 and all of the different stocks and sectors therein.
If you’re not sure what flavor of stock will lead the recovery, why not buy the whole market? And if you’re worried about a correction, why not hide out in a wide array of large-cap holdings to mitigate your risk?
It’s not creative, but it’s effective. There’s a reason Vanguard raked in $130 billion in assets last year — because passive indexing by purchasing a fund like the VOO makes sense. And more importantly, it makes investors money.
Ranger Equity Bear ETF
What if you’re confident that the gains of the first half will stick, but less confident that the second half of 2013 will be great? Then the AdvisorShares’ Ranger Equity Bear ETF (HDGE) might be a great option.
Don’t let the name fool you. Unlike some inverse ETFs out there that simply do the opposite of a major stock market index, the actively managed HDGE ETF takes strategic bets on equities it expects to crash and burn. Top holdings (to the downside, of course) right now include CenturyLink (CTL) and Altera (ALTR) — two stocks that are handily in the red year-to-date despite gains for the broader market.
HDGE is very good at picking bad stocks. Of course, a rising market has made a stiff headwind and the fund is down by double-digits year-to-date … however, it’s down less than other bear funds, and could be a great hedge (as the ticker implies) for the second half.
I interviewed Active Bear ETF manager John Del Vecchio about a year ago, and he explained to me that the strategy is as much a hedge (hence the ticker) as a profit vehicle in down times. That this bearish ETF can hold a bit firmer than peers even when its strategy is out of favor makes that argument pretty compelling.
HDGE, which has about $225 million in assets, charges a steep expense ratio of 3.3% … not a pleasant amount to shave off your profits. However, if you’re not comfortable shorting stocks, then this is an alternative — and one that isn’t all that much more expensive than some platforms considering the short interest expense and fees involved with a bear strategy.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the stocks named here.