ETF Strategies: Five Alternative Plays For 2013

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2013: A Look Back And Ahead

A fully diversified investment portfolio includes a mix of stocks, bonds and so-called alternative assets, which are basically anything that isn't a stock or a bond. This includes hard assets like real estate, commodities and obscure things like market volatility.

Three investment strategists believe alternative assets offer the best upside potential in 2013. They explain which ETFs they're buying for their clients and why.

David Schombert, founder and chief investment officer at Metropolitan Capital Strategies in Reston, Va., with $90 million in assets under management.

MCS believes the U.S. stock market is at an inflection point with a 10% chance of going up to 1550 (on the S&P 500), a 20% chance of going sideways and a 70% chance of dropping between 25% and 50%. Prices in the market throughout 2012 appear to have been driven primarily by perceived news events: U.S. Federal Reserve stimulus efforts, Europe, China and the fiscal cliff.

At some point stock prices will again be determined primarily by fundamentals rather than news events; and when that happens, the deterioration of earnings and revenue in 2012 will become a significant weight on the markets.

In its December meeting, the Fed increased its support for the economy and the stock market in hopes of accelerating growth and maintaining or increasing market values. It is now forecast to pump $1 trillion into the market in 2013 based on current activity (on top of the $2 trillion+ it already pumped in).

MCS believes this money printing by the U.S., and coordinated with other central banks around the world, could lead to inflation and weakening of the U.S. currency. Inflation would show up in the cost of goods people purchase every day such as food and oil. Inflation will then force interest rates to rise on bonds. The 10-year Treasury bond (yield) is at a historic low, under 2%. An increase to its mean of 4% would double yields, causing bond prices to drop.

As this scenario unfolds, MCS will capitalize on the opportunity by using the inverse bond ETFs such as ProShares UltraShort 20+ Year Treasury ( TBT ) and ProShares UltraPro Short 20+ Year Treasury ( TTT ). As prices bounce around during the correction, we could use this play two, three or more times while the bonds plunge in price.

The MCS philosophy and approach is to identify opportunities with double-digit upside (potential) and low risk. When the bond play unfolds, it will meet both of our objectives. While it could occur in 2013, we are not prognosticators. We will be patient and work with what the market gives us, knowing that protecting assets and making appreciation in low-risk time frames leads to better returns for investors. Protection and growth are paramount.

Mark Eicker, chief investment officer at Sterling Global Strategies in Carlsbad, Calif., with $140 million in assets.

A major investment shift has begun. The effects of the 2008 financial crisis profoundly impacted investors' willingness to risk capital as they put trillions of dollars into fixed-income instruments. As the money poured into bonds over the past four years, yields were driven down to record lows. That trend has begun to reverse as the yield on the 10-year Treasury has bounced back from an all-time low of 1.39% to above 1.8% since September. The Aggregate Bond Index is poised to post its first negative quarter since first quarter 2011. That money will continue to flow out of low-yielding bonds and into more traditional balanced asset allocations during the first quarter of 2013.

Our ETF pick for the first quarter of 2013 in the fixed-income space is the ProShares Short 20+ Year Treasury ( TBF ). TBF theoretically rises along with interest rates, which is an inverse relationship that Treasuries have with rising rates. The duration of this ETF is more than 18 (years), which means a 1% move up or down in 20-Year Treasury yields would impact this ETF by approximately 18% in either direction. An inverse Treasury ETF is not for the faint of heart and should never be a large piece of an investment portfolio, but I do believe this will be the best performing fixed-income ETF during first quarter 2013.

Brian Schreiner, vice president of Schreiner Capital Management in Exton, Pa., with $65 million in assets.

The most attractive area in 2013 is volatility investing. In fact, we are treating it as a new asset class. When you understand that market volatility has more impact on portfolios than any other single factor, it certainly makes sense to manage it. That's what diversification is all about. Investing in volatility takes diversification to another level.

There is no shortage of opportunities to profit from volatility because, well, volatility is volatile. The key is being able to capture its trends and anticipate the spikes. The VIX is not something you want to buy and hold. Volatility has its own unique characteristics and must be actively traded.

Our portfolios utilize an active long/short approach that achieves inverse volatility exposure by owningVelocityShares Daily Inverse VIX Short-Term ETN ( XIV ) when markets are calm and long exposure in iPath S&P 500 VIX Short-Term Futures ETN ( VXX ) when market volatility is high.

Volatility trends. When volatility is low, it tends to remain low and when it's high, it tends to remain high. As volatility traders, the goal is to be short volatility during the melt-up and be in cash or long volatility during stock market corrections, when volatility is high.

The upside in volatility trading is huge. Investors can realize triple-digit returns as VXX and XIV tend to be about three times as volatile as the S&P 500 Index. Until recently, the VIX has been trending below its long-term average of 20. Increased volatility may continue as uncertainty around the fiscal cliff negotiations continue to keep markets in flux.

Looking ahead to 2013, further quantitative easing will likely provide continued support to the stock market, keeping volatility below historical norms and opening the door for substantial profits for investors in XIV.

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.

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

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