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Three Types of ETFs That Look Ready to Play Catch-Up in 2014


Some of these plays may take time to develop, but they offer a unique opportunity for additional gains this year.

In the first full week of trading for the New Year, investors are starting to look at new opportunities for their portfolios. As a trend follower, I am always willing to let my winners run until such time as they are starting to fall out of favor. However, I am also on the lookout for sectors that may be undervalued by the majority of the investing community.

The obvious contrarian calls for 2014 have been in the biggest beaten-down sectors such as gold, the VIX (INDEXCBOE:VIX), coal stocks, and even Treasuries. These were some of the worst-performing indices and asset classes in 2013, which would make them excellent candidates for a strong snapback rally. However, I am focusing more on opportunities that have lagged the broader market and may see additional money flows through value rotation.

Emerging Markets

At this point it is no secret that the iShares MSCI Emerging Market ETF (NYSEARCA:EEM) underperformed the SPDR S&P 500 ETF (NYSEARCA:SPY). Emerging market countries dealt with a host of problems last year that included slowing economic forecasts, currency devaluations, and credit worries. This sent investors fleeing from markets in China, India, Brazil, and Russia to name a few.

My prediction in 2014 is that we will see a mean reversion that boosts the relative performance of emerging market countries. Whether that results in the decline of US stocks is harder to determine, however I think that new money will seek undervalued pockets of emerging market strength such as the Guggenheim China Small Cap ETF (NYSEARCA:HAO). This fund is comprised of 250 small-cap stocks centered in China and Hong Kong with over $250 million in total assets.

One of the reasons that I like HAO is that it has massively outperformed its large-cap counterpart in the iShares FTSE China Large-Cap ETF (NYSEARCA:FXI) over the last year.

Small-cap stocks are an excellent way to get exposure to growing segments of the economy that are more in touch with the local consumer. In addition, with HAO you avoid many of the mega-cap China stocks that are dominated by state-run enterprises.

Preferred Stocks

One of the most prominent ETF income value plays that I am currently participating in is through preferred stocks. The iShares US Preferred Stock ETF (NYSEARCA:PFF) was essentially flat in 2013, but has many attractive qualities for dividend seekers. It is currently paying a yield of nearly 6% and behaves as a hybrid instrument with both equity and debt characteristics. In addition, it is still more than 5% off of its most recent highs, which makes a better value proposition than many dividend stocks trading near their all-time highs.

This ETF just recently crossed back above its 200-day moving average, which I view as a bullish sign that it has regained some of the momentum it lost back in the May-August interest rate ramp. If interest rates remain relatively steady this year, PFF has an opportunity to extend this strength and provide a combination of growth and income for your portfolio.

Municipal Bonds

Municipal bonds fell sharply in mid-2013 and have been on a slow rebound after fears of widespread defaults have subsided. The Barclays Municipal Bond Index had its worst year since 1994 and outflows from muni bond funds reached panic levels. However, I believe that most of the credit worries have subsided and investors are going to look to capitalize on tax-free income at some of the best yield in years.

Everyone loves to hate muni bonds, however the lure of tax-free dividends is a strong pull to resist. This is especially true for investors who have large taxable accounts for which they require a consistent and reliable income stream. Consider the 30-day SEC yield on the iShares National AMT-Free Muni Bond ETF (NYSEARCA:MUB) is 2.79% which translates to a taxable equivalent yield of nearly 5%.

If interest rates hold steady or even decline in 2014, I believe that muni bonds will continue their recent upward bias. The greatest threat to this sector would be another wave of inflationary interest-rate pressure combined with a credit default for a large municipality.

My final word of advice for making changes to your portfolio in 2014 is to stay balanced and make incremental shifts to your asset allocation based on your future outlook. Some of these value plays may take time to develop, but offer a unique opportunity for additional gains this year.

Read more from David Fabian, Managing Partner at FMD Capital Management:

2014 ETF Income Investing Ideas: Part 1 – Bonds

2014 ETF Income Investing Ideas: Part 2 – Dividend Equities

2014 ETF Income Investing Ideas: Part 3 – Alternative Strategies

Twitter: @fabiancapital
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