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Bundle Up for 2014 – 5 Best ETFs to Buy

The market might slow down in 2014, but these ETFs are solid buys

By Will Ashworth, InvestorPlace Contributor

What are the best exchange-traded funds to buy in 2014? Most Wall Street strategists expect moderate returns for the S&P 500 in 2014, especially compared to what we’ve seen in 2013.

best-stocks-etfs-mutual-funds-2013-2014It’s unlikely investors will see a second consecutive year of 20% returns, although double-digit returns are entirely plausible. ETF selection in the coming year is even more important as performance becomes harder to obtain.

Where will the big gains be made in 2014? Unfortunately, I can’t tell you that, because I don’t know. However, I can recommend five ETFs I believe you should buy for 2014. It’s unlikely that every single one will post market-beating returns, but I’m confident these ETFs will show solid, stable growth in the year ahead.

Vanguard FTSE All-World ex-US ETF (VEU)

ETFs-vanguardIt’s not that I’m anti-U.S. heading into 2014, I just think there are a number of areas outside of the U.S. that either performed poorly this past year or are going to continue to enjoy above-average returns in the year ahead. With an expense ratio of just 0.15% (or $15 for every $10,000 invested), the Vanguard FTSE All-World ex-US ETF (VEU) is a great, cheap way to buy the world beyond our door steps.

VEU is spread amongst a huge number of countries. At the end of November, a total of 21 countries had a weighting of at least 1%, with Japan the top holding at 16.2% and the United Kingdom in second place with 15.4% of its overall portfolio. Year-to-date, VEU is up 8.9% through Dec. 13, trailing its MSCI EAFE benchmark by 760 basis points. Emerging markets are a big reason for the underperformance, but I see them doing much better in 2014. With VEU investing about 18% of its portfolio in these up-and-coming markets, a turnaround there would certainly help its performance.

With 47% of the $20.2 billion in total net assets invested in Europe, I see good things happening overseas in 2014. VEUs biggest holding — Nestle (NSRGY) — could end up selling its 29% interest in L’Oreal (LRLCY) sometime in the new year. That would bring in a huge amount of cash that it could reinvest in its best-performing business segments, or use to repurchase a significant number of shares.

RevenueShares Financials Sector Fund (RWW)

etfs-revenuesharesThe RevenueShares Financials Sector Fund (RWW) uses revenue rather than market cap to weight each of the 81 stocks in its portfolio. For this reason Berkshire Hathaway (BRK.B) is No. 1, at 11.3%. Year-to-date through Dec. 13, the fund is up 37% — a full 10 percentage points higher than Warren Buffett’s holding company and the S&P 500. Financial stocks have now had two good years in a row. I see Berkshire Hathaway being a big contributor to a third consecutive year outperforming the index.

RWW is one of six ETFs that hold BRK.B at a weighting of more than 5%, and is the most expensive of those in terms of management fees at 0.49%. That’s much more expensive than the Financial SPDR Fund (XLF) — the market cap version of the S&P 500 Financials index — which holds BRK.B at a weighting of 7.94% and has an expense ratio of 0.18%. However, the RWW has beaten the XLF on an annual basis in four of the last five years. Long-term the additional fees are worth it.

In November, two analysts from AQR Capital Management and a professor from New York University published a revised draft of a May 2012 paper entitled Buffett’s Alpha, which sought to examine why Warren Buffett’s performance has been so good over the years. The authors concluded: “ … the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails.” Whether it be Berkshire Hathaway’s private or public holdings, leverage has helped juice its returns.

While I don’t like every holding of Buffett’s, I continue to see good things for his firm in 2014; RWW is the best way to benefit from BRK.Bs success.

PowerShares S&P Emerging Markets Low Volatility Portfolio (EELV)

etfs-EELVAs tempting as it is to pick one of Charles Sizemore’s top five emerging market ETFs for 2014, I’m going to want a broader take on emerging markets considering that VEU has just 18% invested in those markets. That’s why I’ve chosen the PowerShares S&P Emerging Markets Low Volatility Portfolio (EELV), which tracks the 200 least-volatile stocks of the S&P Emerging BMI (broad-market index) plus LargeMid Cap Index over the last 12 months.

Unlike many of the broad-based emerging market ETFs, China isn’t the top-weighted country. In fact, it’s all the way down in fifth with a weighting of 8.91%. Ahead of China are South Africa, South Korea, Malaysia and Taiwan at No. 1. Also attractive is the fact Colombia, Mexico, Chile and Brazil are represented in the top 10 holdings. I have a soft spot for Latin America and companies doing business in the region.

Some might not like this recommendation when combined with RWW because EELV is 33% invested in financials. However, the RWW is invested in financial stocks that generate a significant amount of business in the U.S. and other developed countries while the financial holdings in EELV generate most of their revenues from emerging markets. While there’s some overlap, it’s not enough for me to back away from this recommendation. I see a good year for EELV in 2014.

First Trust US IPO Index (FPX)

etfs-fpxIPOs are having a bumper crop in 2013, and experts suggest 2014 will be even better. Ernst & Young says that in the first quarter alone, we could see as many as 300 deals totaling $45 billion on a global basis.

Given that there aren’t a whole lot of ways to play this trend, the First Trust US IPO Index (FPX) becomes a natural choice. Up 42% year-to-date through Dec. 13, and up 29% on annualized basis over the past five years, this is one of the hottest ETFs out there.

FPX invests in 100 of the largest IPOs in the US that are part of the IPOX Global Composite Index, a group of approximately 2,300 companies with a total market capitalization of $1.4 trillion. Once a stock enters the IPOX-100 U.S. it’s held for 1000 trading days and then sold automatically. In comparison, the Renaissance IPO ETF (IPO), which only came into existence in October, utilizes a fast entry system, which leads to much different holdings.

Renaissance Capital, the company behind IPO, has a rich history providing IPO information. However, its Global IPO Fund (IPOSX), which has been in existence since 1997, has a dreadful record. There’s simply no comparison between the two companies’ products. While FPX might not give you the hottest IPOs as soon as they hit the markets, you will get an ETF that’s simply constructed and designed for superior performance. Although there’s a lot of hype right now about the IPO markets, I believe the hype is real. Look for FPX to perform once again in 2014.

iShares MSCI Canada ETF (EWC)

etfs-ewcI thought I’d save my own backyard for last. It’s not that I think the U.S. markets are going to do poorly in 2014, it’s just that the iShares MSCI Canada ETF (EWC) has seriously underperformed the SPDR S&P 500 (SPY) over the past three years and is due for a little love from the ETF gods. In addition, 25% of EWC is invested in energy stocks, and many pundits are calling for the sector to continue to do well in 2014, despite signs that global economic growth is slowing.

Of the five ETF picks I’ve made, this is the one I’m most skeptical about — 38% of the portfolio is invested in financials, with six of the top 10 holdings Canadian financial institutions. I recently rated the six major Canadian banks in terms of investment attractiveness. My biggest concern with all of them is the stagnating Canadian mortgage market that’s a result of higher real estate prices and more stringent mortgage regulations. Homes are simply becoming unaffordable for many living in major cities like Toronto and Vancouver. Add the possibility of rising interest rates, and banks north of the border could face some serious revenue shortfalls.

At the end of the day, however, I see a correction coming for the simple reason that a cumulative return of -2% over the past three years when most of the rest of the world has seen equity markets do exceptionally well suggests reversion to the mean is about to set in. It might take a few months, but by mid-2014 I see good things happening for EWC despite the storm clouds hanging about.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

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