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7 Great ETFs to Build an Asset Allocation Strategy


All of these exchange-traded funds represent some of the most important investment asset classes and have a strong options market, which permits effective hedging.

My firm's favorite ETFs for building an asset allocation strategy are fairly obvious -- we write about them all the time:
  • SPDR S&P500 (US Large Cap) (NYSEARCA:SPY)
  • SPDR S&P Mid-Cap (US Mid-Cap) (NYSEARCA:MDY)
  • iShares Russell 2000 Index (US Small Cap) (NYSEARCA:IWM)
  • iShares MSCI Emerging Markets Index (Emerging Markets) (NYSEARCA:EEM)
  • iShares MSCI EAFE Index (Developed Countries) (NYSEARCA:EFA)
  • iShares iBox Investment Grade Corporate Bonds (Fixed income – Investment Grade) (NYSEARCA:LQD)
  • SPDR Barclays High Yield Bond (Fixed Income – High Yield) (NYSEARCA:JNK)
These ETFs all represent some of the most important investment asset classes. Just as important, all of these ETFs have a strong options market, and that permits effective hedging.

The market has had a surprising run here in early 2013. The YTD returns on these asset classes definitely show that investors' appetite for risk is strong. The US equity market is leading the way. Mid-cap and small-cap in particular are distinctly outpacing the large-cap arena: + 7.5% and +6.5% vs. +5.5%, respectively.

Meanwhile emerging markets and investment grade bonds are down less than 1%. High yield is close to +2% and developed countries is up around 4%.

The market is hitting multi-year highs. So, the question is: Can you believe in this rally? I will believe it if earnings season justifies it. So far, earnings season really doesn't justify these premium multiples for US markets. However, this week and next week are the two busiest weeks of earnings season, so we'll know in about three more weeks whether we can still believe in this market.

One thing is for certain: I think this would be a great time to consider a portfolio rebalancing if your US large-cap, small-cap, and mid-cap are all overweight to your target asset allocation. In particular, consider the rebalance if it has been at least six months since your last one.

Among these asset classes, I like the two international asset classes the most. They still trade at the largest discounts to their earnings potential than any other asset class. So, a rebalance is likely going to result in some additional purchase of international asset classes like those represented by EEM and EFA.

Now, EEM and EFA have had an impressive run over the last six months, so it is possible that those classes are overweight also. My recommendation is the following: Consider decreasing your fixed income or US equity target allocation by around 5% and move that 5% in to your international position. It is still the asset class trading at the best discount.
No positions in stocks mentioned.
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