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How to Construct a Sophisticated ETF Growth Portfolio

Several weeks ago, I laid out a roadmap for creating a sophisticated ETF income portfolio using a variety of innovative asset classes designed to work in harmony together. The foundation of this strategy focused on core positions as the initial building blocks from which you add tactical and special situation funds.

The rationale behind this process is that core holdings give you correlation with the market and low-cost index exposure. In conjunction with that allocation, you can enhance your returns by overweighting specific sectors, active strategies, or undervalued opportunities that may provide a measure of alpha above a traditional benchmark.

While much of this same philosophy can be carried over from an income portfolio to a growth strategy, the majority of growth investors have markedly different goals, risk tolerance levels, and time horizons. This allows them the flexibility to be more aggressive in certain areas and seek out opportunistic trading setups when they present themselves.

Core Holdings

Core growth positions often align themselves with major domestic indices such as the SPDR S&P 500 ETF (SPY) or the Vanguard Total Stock Market ETF (VTI). Both of these funds provide dirt-cheap access to a diversified basket of equities in a market-cap weighted index. While that composition might suit the majority of investors, with so many ETF options to choose from, you can even build core holdings around innovative index constituents.

One strategy that has proven successful over the last several years is an equal-weighted methodology that can be accessed through the Guggenheim S&P 500 Equal Weight ETF (RSP). While RSP has the same 500 underlying stocks as SPY, each holding is given an equal allocation of assets which puts a larger emphasis on smaller companies. Many of these relatively smaller stocks are often seen as growth engines compared to their mega-cap peers, and as a result can enhance returns in a bullish environment.

Another strategy that might provide an alluring quality is to specifically target growth companies within an underlying index. The Vanguard Growth ETF (VUG) provides access to 370 underlying large-cap stocks with an emphasis on technology and consumer discretionary names. Many of the underlying holdings in VUG are focused on growing their businesses by reinvesting profits in R&D and other core development initiatives rather than distributing capital back to shareholders.

Tactical Positions

Tactical positions represent a sector, industry group, or special situation that you want to take advantage of. They also give you a measure of overweight exposure towards a certain area of the market that you feel is offering excellent potential for capital appreciation.

One area that I recently analyzed as a potential tactical opportunity is the Health Care Select Sector SPDR (XLV). Several of the underlying holdings in XLV, particularly in the biotech industry, are still well below their recent highs and I believe the fundamental factors supporting the health care theme are sound.

ETFs also offer you the ability to dig beneath individual sectors to select industry groups as well. For example, the First Trust NASDAQ Clean Edge Green Energy Index (QCLN) gives you targeted exposure to companies that are engaged in emerging clean energy technologies such as solar, biofuel, and advanced battery equipment.

Many of the 50 underlying stocks in QCLN have experienced significant share gains in recent years and may offer cutting-edge advancements in new technology down the road. While individual industry groups can be more volatile, they still offer long-term growth potential in niche fields.

Another way to think of tactical opportunities with ETFs is through non-traditional asset classes such as currencies, commodities, or even volatility indexes. Many of these areas have become more attractive recently in light of the easy ability to access them in an ETF format.

For instance, the WisdomTree Bloomberg US Dollar Bullish Fund (USDU) is one way to capitalize on the strength of the US dollar versus a basket of major foreign currencies. The US dollar has recently gained momentum with news of quantitative easing efforts from the European Central Bank that is disbursing the euro lower. If that trend continues, it could market a significant shift in currency markets this year.

The Bottom Line

The investing landscape is constantly shifting for growth investors and staying ahead of the game requires research and discipline to select holdings that meet your needs. With the market at new highs, you should be constructing a watch list of positions that you want to add on a pull back and looking to average into them slowly. That way you can use time and price to your advantage as the rest of the year unfolds.

No matter how you ultimately construct your growth portfolio, one thing I always return to is that risk must be managed to preserve capital during pernicious downturns. ETFs make it easy to set a trailing stop loss or other sell discipline as a preventative safety mechanism. That way you don’t get stuck in a bad trade that turns into a bad long-term investment.

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.