ETF Investing For Q3: 10 Ideas From 10 Strategists


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If you were stranded in a stock market pit and could have only one ETF in the third quarter, which would you pick?

Here's what a group of asset managers and investment strategists are recommending for successful investing .

1. Jeff Vollmer, managing principal at Hyde Park Wealth Management in Cincinnati, Ohio, with $240 million in assets under management:

IShares Dow Jones U.S. Regional Banks Index ( IAT ) presents a powerful case to forward-looking investors, offering positive valuations and the ability to climb the wall of worry in a rising-interest-rate environment.

Companies in IAT can increase profits in such an environment. The Federal Reserve has stated its intention to hold short-term interest rates near zero until inflation reaches 2% or the unemployment rate reaches 6.5% or less. Most economists believe these targets could take a year or two to achieve. Meanwhile, long-term rates will increase as the markets expect better economic growth in the years ahead.

As rates creep higher, regional banks continue to pay nearly nothing to customers' savings accounts, even as the banks begin to make considerably more on their commercial loans and mortgages. This disparity between what they pay and what they make is called their "net interest margin." NIM works as a proxy for bank profitability.

Rising rates and an improving real estate market can serve as a catalyst for potential homebuyers, who choose to buy sooner than later in order to avoid future rate increases. Banks benefit by increased lending volumes as well as bigger bank deposits, as people save more money in interest-bearing savings accounts as opposed to allocating capital to riskier assets.

Many, if not most, regional bank stocks remain roughly 50% below their 2007 prices. But they have recently begun to appreciate as the specter of rising interest rates takes hold.

IAT offers significant upside from a historical price and a current valuation perspective. It reached 53 in 2007. Today, it trades 44% below its 2007 high. The S&P 500 trades at a price-earnings ratio of 15, while IAT trades at a considerable discount of 13 times forward earnings.

Should markets get volatile, or if the economic data begin to sour, regional banks could sell off. Like any position, IAT should represent no more than 3% to 5% of any portfolio.

2. David Brown, chief market strategist, Sabrient Systems in Santa Barbara, Calif.:

First Trust Nasdaq Technology Dividend TDIV Index ( TDIV )

To the surprise of many investors, technology stocks have seen higher growth of dividends over the past 10 years than any other sector. According to Nasdaq OMX, dividends in the tech sector have had the highest annualized growth of 24.27% per year over the past 10 years. Oil and gas stocks have had only 12.75%, and utilities just 7.52%.

The forward price-earnings ratio is another consideration. The average forward P/E of the stocks in TDIV is in the lowest 8% of all P/Es in traded ETFs . So clearly they are not overvalued at this point. It has not been a particularly good year for tech stocks (Apple ( AAPL ), for example), but because of TDIV's low forward P/Es, the odds are that not only are the dividends likely to grow but the stock prices should increase too.

TDIV has 74 constituents and over $150 million in the trust. TDIV is made up of 80% technology stocks and 20% telecommunication stocks. The stocks are selected on the basis of dividends (using a dividend-weighted formula). The higher the dividend paid, the higher the weighting given the stock in the portfolio.

TDIV ranks in the top 93% of the market based on return on sales, return of equity and return on assets for each constituent of the ETF.

Technology stocks in general could continue to underperform the market. But I don't think this is likely because of the simple fact that for many, many years technology has been among the fastest-growing sectors. There's no reason technology won't be able to cast off the current gloom and return to strong growth, as advances continue throughout the tech industry, such as cloud computing, enterprise software, broadband as Internet users expand, semiconductors, and areas that are not yet a glimmer in our collective minds.

Even if technology stocks continue to underperform, that should have little or no effect on the dividends. In general, tech companies -- and especially those in TDIV -- have enormous amounts of cash, so there is little risk of not being able to cover dividends. Keep in mind that the dividends paid by utilities are often close to the amount of their earnings. With tech stocks, it's just the opposite.

For all these reasons, we recommend taking a hard look at TDIV as a good investing idea.

3. Michael Needleman, senior partner at Fusion Analytics Investment Partners in New York, with $500 million in AUM:

First Trust NYSE ARCA Biotech ( FBT )

Morningstar considers FBT a growth ETF that is 100% invested in health care, with over 80% of the allocation in biotech, 10.3% in health care products and 9.4% in pharmaceuticals. Stocks in the ETF have an average price-earnings ratio of 20.76 and an average price-to-sales ratio of 3.14.

The top 10 holdings areIllumina ( ILMN ),Affymetrix (AFFX),ImmunoGen (IMGN),Regeneron (REGN),InterMune (ITMN),Sequenom (SQNM),United Therapeutics (UTHR),Nektar (NKTR),Biogen (BIIB) andAlexion Pharmaceuticals (ALXN).

A majority of the companies in FBT are domestic, so the overall global economy should not affect this ETF. The larger biotech names have a number of new drugs on the market that can continue to drive stocks higher. Consolidations, or mergers and acquisitions, of biotech companies are likely to continue. The main risk is that biotech stocks in general are volatile.

We recommend placing a stop loss at 54, which is the 100-day moving average.

4. Jonathan Citrin, executive chairman of CitrinGroup in Birmingham, Mich., with $60 million in AUM:

IShares MSCI Brazil Capped Index (EWZ)

Having lost already almost half its value in 2013, the equity market in Brazil continues to receive negative glances. What was just a few years ago the golden child of portfolios has quickly been abandoned as most have looked toward the U.S. and other developed nations for near-term growth.

The economy of Brazil is a major benefactor of export growth. EWZ is a potential bargain because it currently trades at levels not seen since the Great Recession of 2008. Whether due to increased demand from abroad, especially for natural resources, stimulus from within or simply the desperation of investors looking for opportunity amid central bank tightening elsewhere, Brazil is well-positioned for a run in the third quarter.

It may be a hair early, and the true bottom is almost always unknown. But the powerful economy of Brazil will play more than a supporting role in the shaping of our global economic future. For those lacking exposure or waiting for a signal, now is the time to get into this emerging and potent economy.

5. William Harris, managing member at WH Cornerstone Investments in Duxbury, Mass., with $40 million in AUM:

WisdomTree Europe Hedged Equity (HEDJ)

Most foreign stock and bond indexes have fallen even more than the U.S. markets. In general, the selling pressure has been heavier abroad than in the U.S. Even so, my top ETF pick for the third quarter is a bit contrarian. Since all markets appear a bit squirrelly, I feel safe holding true global powerhouses, companies likeAnheuser-Busch InBev (BUD),Sanofi-Aventis (SNY),Unilever (UN),Siemens (SI),Daimler (DDAIF),Banco Santander (SAN) and Bayer.

Many of the world's leading brands are headquartered in Europe. They are global companies that generate tons of revenue from Europe and countries outside the eurozone. These companies are solid. I anticipate exports, and ultimately earnings, to increase in the second half of the year. Geopolitical news and looming sovereign defaults will haunt European stocks for the foreseeable future.

The biggest risk of investing in Europe is the euro. HEDJ gives exposure to truly great global companies, while hedging exposure to the euro. HEDJ neutralizes exposure to currency fluctuations between the euro and the U.S. dollar. Ignoring the local currency can turn a good investment into a bad one. With HEDJ, you can ignore the currency risks.

HEDJ is made up of the largest dividend-paying companies that are domiciled in Europe and are traded in euros.

6. Michael Bapis, partner and managing director of the Bapis Group in New York, with $850 million in AUM:

Large-cap ETFs

Given the recent market pullback, we would use this time as an opportunity to slowly add to growth and value large-cap equities. Short term, we will have continued volatility and an overly sensitive environment, but longer term we would look to own high-quality equities and we remain bullish. In the coming weeks, the volatility may be extreme and markets highly sensitive, but large-cap equity remains undervalued.

While we navigate through an extremely difficult interest-rate environment, large-cap stocks still have low prices relative to earnings as well as high dividend yields, which investors are starving for.

The rapid rise in interest rates is a sign of an improving economy. The tapering of the Federal Reserve's purchases and most recent employment numbers signify this, as well.

We are most optimistic on technology. Recently, large-cap tech companies have been beaten down. Across the U.S., many businesses are beginning to upgrade equipment and infrastructure, which will lead to better-than-expected revenue numbers for the sector.

7. Jackie Ann Patterson, founder of Backtesting Report in Woodside, Calif.:

IShares Russell 2000 Index (IWM).

I look at roughly the past six months' performance of several ETFs representing U.S. stocks, U.S. bonds and international stocks. Historical backtesting has shown that choosing to invest in the ETFs with the largest percentage gains has led to profits -- at least when applied to ETFs that track broad stock and bond indices. "Heat-chasing" the latest short-term run-up in a narrowly defined sector too often ends in failure.

IWM has been leading the other index ETFs throughout the year. IWM appears poised to lead going forward as well, as bond returns are negative. The international funds were hurt by the rise of the dollar, and the large-cap indices trail lately. IWM is up 20% over the last 140 trading days.

IWM invests in up-and-coming small-cap stocks such asAegerion Pharmaceuticals (AEGR), which gained 137% since the beginning of 2013. The small-cap domain also includes beaten-down players such asKB Home (KBH) andCoeur D'Alene Mines (CDE), which could make a comeback in a strong market.

With 2,000 companies in the index, a single company's meltdown is not likely to do much damage to IWM.

The third quarter always carries the risk of the summer doldrums, when market players seem to take a holiday and let the prices sag. Small-cap indices tend to be more volatile, so broad market pullbacks could be more pronounced for IWM. If the trailing six-month performance of IWM were to drop to a loss, I would revise my position in IWM.

8. Kevin Rich, founder of Rich Investment Solutions in New York, with $5 million in AUM:

ALPS U.S. Equity High Volatility Put Write (HVPW) .

Recently, investors have become nervous, disquieted by Fed talk and uncertainty about the continuation of quantitative easing and the strength of the economy. Equity markets have become unsettled as exhibited by increased volatility. In this environment, the preferred investment is one that is able to behave defensively while allowing the investor to still participate in an increasing equity market.

HVPW is an income-generating fund that creates its income by selling two-month 15% out-of-the money put options on a selection of 20 diversified stocks that have the highest implied volatility.

HVPW can be viewed as a "low" volatility strategy. Despite the fact that HVPW sells put options on some of the highest volatility stocks, the fact that it sells options on a diversified selection of 20 large-capitalization stocks with strike prices that are 15% out of the money allows HVPW to experience lower volatility than the broad market. HVPW can be viewed as a defensive long-equity position, while generating relatively high income.

Selling options is a very popular and effective way to generate income in the equity markets. Many investors are familiar with selling call options on a stock they own, which is called "covered call writing."

Selling put options collateralized by T-bills is not as well-known a strategy as covered call writing, but "put writing" offers the same benefits plus distinct advantages over call writing, such as the ability to provide additional downside protection and the ability to generate income from the collateral T-bills.

HVPW should perform well in upward-trending and sideways-trading markets, and may perform better than the broad market equity funds in downward-trending markets because of the downside protection it provides. In extreme bear markets, HVPW will probably perform poorly just like the broad market equity funds but with some downside protection.

9. Adam S. Drake, partner at Highland Investment Advisors in Milwaukee, Wis., with $30 million in AUM:

IQ Merger Arbitrage ETF (MNA)

A merger arbitrage or "MA" strategy may provide an attractive alternative to bonds in a rising-interest-rate environment. MA is an investment strategy employed by hedge funds in which they simultaneously buy stock in a company for which an acquisition has been announced and short the stock (or a proxy for the stock, e.g., an index fund) of the acquiring company.

MNA offers investors a noncorrelated risk reduction asset for their portfolio. Do not expect exciting returns; the fund's objective is to dial down the overall risk of a portfolio through diversification and noncorrelation to stocks and bonds.

For example, for the 10 years ending March 31, 2013, the HFRI Merger Arbitrage Index had a correlation of 0.67 to the S&P 500 Index and 0.07 to the Barclays U.S. Aggregate Bond Index. The Merger Arbitrage ETF does not produce income.

MNA is not a pure MA strategy as it uses the overall market as a short proxy instead of the acquiring firm. The return generated for the investor is the spread. The spread is determined by the risk-free rate (short-term Treasury Bills) plus a risk premium. The risk premium is based on several factors, one being the probability of whether or not the deal will come to fruition.

Examining historical HFRI MA index data, returns were generally higher for the MA strategy in the 1990s, when interest rates were higher.

Returns moderated through the 2000s in tandem with falling interest rates.

With current interest rates at or near zero -- specifically short-term Treasuries -- MA returns are almost entirely attributable to risk premium. Should interest rates rise, so too should MA returns.

MNA is a small ETF with thin trading volume and a relatively short track record. Alternately, there are several mutual funds using the MA strategy with longer track records that an investor could consider. Also, if interest rates go down or stay flat, the fund's performance could be flat or down. The fund can be concentrated, and thus nondiversified. Returns are somewhat dependent on the overall health of the MA market. Deal volume may go down, and those deals that are announced could be canceled or extended.

10. Will Rhind, managing director of ETF Securities in New York, with $20 billion in AUM:

ETFS Physical Platinum Shares (PPLT)

PPLT tracks one of the few commodities in which demand is currently outstripping supply. The main source of demand for platinum is in catalytic converters, which clean exhaust emissions on vehicles. Global auto sales have been steadily increasing in the last few years since reaching a bottom during the global financial crisis of 2008. Global vehicle sales increased 5% in 2012 to approximately 81 million units.

Platinum also has strong demand from the jewelry industry, particularly for wedding bands and other high-end designs. Platinum jewelry demand in China rose to near record levels in 2012 as the platinum price traded at a discount to gold for a large part of the year. Rapidly improving global lifestyles coinciding with increasing demand for motor vehicles and additional emission regulations are likely to sustain strong underlying demand for platinum in the years to come.

About 80% of the platinum in the world is produced in South Africa, which amounts to a huge concentration risk for global supply of the metal.

As platinum is more of an industrial metal, the main risks to the price of platinum in the near term would be a significant slowdown in global gross domestic product and subsequently global vehicle production.

PPLT tracks the spot price of platinum and is backed by physical platinum bullion in a secure vault.

Follow Trang Ho on Twitter @TrangHoETFs .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: AAPL , FBT , IAT , ILMN , TDIV

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