McCall’s Call: Build A Nest Egg In A Storm

The market has hit the “reset” button over the last month and is now officially in correction mode after the first downgrade of U.S. debt in history. The somewhat expected downgrade S&P last Friday sent world markets to new 2011 lows and well off the multi-year highs set earlier this year.

The sudden and dramatic selloff in nearly every asset class, except Treasurys, might be the start of a new bear market or the best buying opportunity of the year. I tend to lean towards the latter, and therefore feel it’s appropriate to look at ETFs that could be used to build a portfolio.

I’ll assume for the purpose of this discussion that an investor is new to the market, so the goal is to build an all-ETF portfolio from the ground up. And what better time to do this than after stocks have fallen more than 10 percent from their recent highs. So, I’ll highlight the 10 ETFs I think are now cheap and good long-term investments.

Sector ETFs

Some parts of the economy are going to do better than others, and luckily for ETF investors there are easy ways to gain exposure to those trending or dependable areas, such as healthcare.

• Take the iShares Dow Jones U.S. Pharmaceuticals ETF (NYSEArca:IHE). It’s composed of 39 U.S. drug stocks, with a heavy concentration on the large-cap sector. The top 10 holdings make up about 58 percent of the entire ETF, with Johnson & Johnson ( JNJ ) and Pfizer ( PFE ) the top two holdings. IHE’s nearly 20 percent pullback in a month from an all-time high has created an attractive entry level for long-term investors. It has a 0.47 percent annual expense ratio and a dividend yield of 1.3 percent.
• The SPDRs Select Sector Utilities ETF (NYSEArca:XLU) is a dividend play too, but it’s also an ETF that should outperform the market during times of extreme volatility and selling. It is made up of 35 utility stocks, mainly electric utilities that are based in the U.S. Its low expense ratio of 0.20 percent and an above average dividend yield of 4.4 percent make the ETF even more compelling to long-term investors. And, more to the point, while XLU recently hit a fresh 52-week low, it has held up better than many of its peers.
• The First Trust ISE Cloud Computing ETF (NYSEArca:SKYY), launched in July, is a newcomer to the world of tech ETFs. It is made up of 40 stocks that are either directly involved in the cloud computing business or have indirect ties to this information-technology niche. While SKYY has experienced a rough first month given all the selling, I think this sector is likely to produce many of the next great technology stocks. Buying into the current weakness and building a position is my recommendation. The ETF has an expense ratio of 0.60 percent.
• Oil is another area worth looking at closely. I like the IQ Global Oil Small Cap ETF (NYSEArca:IOIL), the first and only ETF to concentrate solely on small-cap names within the energy sector. The ETF began trading in May of this year and has taken a big hit recently due to the drop in the price of oil. That makes it attractive. With 64 stocks and less than 50 percent of them in the U.S., the ETF offers diversity for those investing in the oil industry. I chose IOIL as a way to access the energy sector because, historically, small-cap energy stocks have tracked the price of oil most closely. I think $80 per barrel oil is a bargain, and my firm is recommending IOIL as the way to play rising oil prices. The expense ratio is 0.75 percent.

Commodities

A boom in commodities is starting its second decade about now, so I view any pullbacks in materials, whether industrial or agricultural, as an opportunity to buy a hot asset class at bargain prices.

Even though many believe the commodity bull market is getting long in the tooth, several macroeconomic factors are still in place for the trend to continue.

• I have a few commodities-related securities on my radar screen, including the iPath Dow Jones-UBS Grains ETN (NYSEArca:JJG). It reflects the returns of an investment in the futures contracts of three grain commodities:corn, soybeans, and wheat. I like JJG, and am recommending it, based on increasing global demand in the coming years at a time when supplies are struggling to keep up. It’s a play on a weak dollar too, as most commodities are priced in dollars, and it offers portfolio diversification as well. The expense ratio is 0.75 percent.
• Another commodities ETF I like is the iShares Gold Trust (NYSEArca:IAU), which tracks the day-to-day price of gold bullion. IAU has actual physical gold backing up the shares in vaults around the globe. Its expense ratio is 0.25 percent, lower than any other physical gold ETF on the market. IAU and its more well-known competitor, the SPDR Gold Shares (NYSEArca:GLD), are up 26 percent in 2011 as gold reaches historic highs. Gold ETFs are my firms largest holding, and we like it going forward. That said, I don’t recommend buying at the highs. Look for weakness on IAU around a price of $16 area. It’s now trading just above $17 a share.

Emerging Markets

A major part of the commodities boom is the demand pull from rapidly developing countries, such as Brazil, India and especially China.

• An ETF that goes to the heart of that development story is the EG Shares Dow Jones Emerging Markets Consumer ETF (NYSEArca:ECON). It’s composed of 30 stocks in the consumer goods and services sectors within emerging market countries. They include retailers, food & beverage, automakers, media, and more. Mexico makes up 20 percent of the ETF, followed by Brazil, South Africa, India, and Chile. This ETF is truly a pure-play on the emergence of middle classes in the emerging markets. As wealth is created, the demand for goods and services will increase, benefiting this ETF. The expense ratio is 0.85 percent. After hitting a new high in July, the ETF has fallen on rough times, and is thus again a buying opportunity.
• The EG Shares Emerging Markets High Income Low Beta ETF (NYSEArca:HILO) is a new ETF that is designed to offer a greater dividend yield and lower relative volatility than the MSCI Emerging Market Index. The ETF is composed of 30 stocks with Malaysia (18 percent) and South Africa (17 percent) the two largest countries in the allocation. HILO has a 0.85 percent expense ratio, and the index has a dividend yield of 5.5 percent. I view this ETF as a new and exciting way to invest in the emerging markets for investors seeking lower risk and income.

High Income

Dependable fixed-income ETFs are essential to any credible asset allocation plan, and I have a couple that I often recommend.

• To regular readers of this column, you’ll recognize the SPDR Barclays High Yield Bond ETF (NYSEArca:JNK), which I mention quite a lot. JNK is composed of over 600 individual corporate bonds that are rated below investment grade. The current yield on the ETF is 8.5 percent and its expense ratio is 0.50 percent. The junk bond sector took a big hit during the recession, but since the bottom it has been a top performer with a large yield. However, the bottom was once again pulled out from under it in all the recent selling. It has lost 10 percent in less than a month. In my opinion, the pullback has created a great buying opportunity for investors looking to gain exposure to fixed income with above-average risk and above-average yields.
• Another prospective fixed-income ETF is the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca:EMLC). It contains a variety of bonds issued by developing countries and denominated in local currencies. By investing in the local currency, investors will either benefit or suffer from currency fluctuations. That said, my view is that the dollar will continue to fall and therefore the conversion in funds like EMLC will benefit U.S. investors. The current yield is 6.2 percent and it has a net expense ratio of 0.49 percent. As I’ve been saying, buying into recent weakness is a good strategy to begin building a position.

Start Building

I consider the 10 ETFs above to be great starting points for the average investor who has at least 10 years until retirement.

Anyone nearing retirement may want to consider a more conservative allocation, perhaps one with an overweight of bonds that are due to mature sooner rather than later.

That said, we all have different risk levels and goals, and therefore individual investors should consult an advisor before making any decisions. Also, in the spirit of full disclosure, we currently own shares of JNK, ECON, IAU, JJG, and IHE.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a New York-based wealth management firm specializing in investment strategies using ETFs.

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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.