Scott Burns: Using ETFs to Invest in the New Normal.
Hi there, I'm Scott Burns, director of ETF analysis with Morning Star. Recently, we had Bill Gross speak at our investor conference here at Chicago, and he talked a lot about the phrase "new normal." New normal is actually a term coined by his colleague Mohamed El-Erian at PIMCO, and what it really talks about is what investors can expect going forward in the next 10-20 years in the market.
Specifically, it means that we should expect the private sector will de-lever, the public sector will re-lever, and we will have re-regulation and we should expect de-globalization.
Our take on that, and what it really means for investors, is that first, you can expect lower corporate returns as companies lower their balance sheets. Second, we should expect higher inflation as the governments inflate their balance sheets. Then, government intervention and maybe even protectionism.Read Full Transcript
Overall what this means globally also is that developing markets should grow at a slower pace, while emerging markets will continue to grow at a faster pace, although a little slower than they have over the past ten years.
Are there ETFs out there you can use to play this new normal? Should you have them in your portfolio? We think yes. In our Morningstar ETF Investor Newsletter, we run a tactical hands-on portfolio. We've been acting on the new normal even before Mr. Gross and Mr. El-Erian really introduced this principle, so it's worked out well for us. So a couple of funds for you to think about.
One, of course, is having a broad exposure to emerging markets. We think that's key to any asset allocation portfolio. We have a couple of favorite funds that we look at. One is Vanguard Emerging Markets, the ticker is VWO. The other is iShares MSCI Emerging Markets Fund, and the ticker is EEM.
The Vanguard fund is a quite a bit cheaper; the iShare's fund is quite a bit more liquid. Depending on what your needs are, you can invest accordingly. Even though if you get emerging market exposure that may not exactly get you the kind of exposure in emerging market consumers that you're looking for.
A lot of emerging market economies are very top-heavy in commodities, financials and telecoms, a lot of former government companies. There are a couple of funds that we like that really get you very nice small cap exposure. One of them is Market Vector Small Cap Brazil, the ticker is BRF. This is a new fund, but it's really caught on. What it does is that, it gives you Brazil exposure, at a level lower in a way from a lot of their commodity-based type companies, so it gets you into their retail and consumer.
The other more broad fund that we like to take a look at, and that we actually own in our hands-on portfolio, is the Wisdom Tree Emerging Market Small Cap Dividend Fund. This fund is small cap emerging market and has a nice value tilt. It keeps you away from things like financials and commodities, because most of those companies are very large and not in the small cap space. And it again gets you into that consumer play on betting that the emerging market consumer will continue to develop and get richer.
In terms of protecting yourself against inflation, the ETF universe offers two very compelling products. One is the iShares Barclays Tip Fund, TIP as the ticker. That gets you very nice US tip exposure.
The other is the SPDR DB International Government Inflation Protected Tip Fund, and the ticker on that is WIP. That actually gets you inflation-protected exposure to foreign markets. So you get to invest in European and some Asian inflation-protected securities. So if you're worried about the dollar or you're worried about how the Treasury calculates CPI, you can actually hedge your investments with a little international exposure there.
In terms with dealing with lower expected corporate returns in the future, one of the things Mr. Gross advised was investing in income-generating assets going forward. In the past a lot of stock market returns have actually come from capital appreciation, or at least that's what the investors were expecting. Mr. Gross says over the next 20 years, we should flip that on its head and look for things that produce income, whether its dividends or interest income.
In terms of dividends, there are a couple of very nice funds out there. The ETF world has a whole suite of dividend-themed ETFs out there. One of our favorites is the Vanguard Dividend Appreciation Fund, VIG. We own that in our hands-on portfolio.
This fund actually has a lower dividend yield than the S&P 500 right now, but that actually reflects the higher quality companies that are in this fund. We think in terms of protection of your security, you won't get as much juice in the dividend yield, but I don't think you will experience as many losses and volatility in it.
For those investors looking for a little more yield, we recommend checking out the SPDR Dividend Fund, SDY is the ticker. This invests in companies that are a little riskier, its dividend field is significantly higher than the S&P 500 right now, so you get more yield, but for more yield you take on a little more risk.
Finally, one of Mr. Gross's points was to talk about how PIMCO is shaking hands with the government. He actually referred to it more as a "fist bump" with the government because he didn't quite trust how fickle the administration has been lately with how they deal with things.
This is a much harder one to play, but for investors that are looking to get into the government backing of securities and the insurance of things, we would recommend the iShares Barclays MBS Bond, ticker MBB. This invests in Freddie Mac paper, Fannie Mae paper, which is all secured by those companies, which is then, in fact, secured by the government. Currently, we think it is treasury like security at above treasury like yields.
So ETFs, with their diversification and their democratization of investment classes, can allow a savvy investor to really invest and hedge their portfolio for the new normal, going forward. Thanks.
I'm Scott Burns, director of ETF analysis. For this and other ETF information, please check out www.morningstar.com, and also check out Morningstar ETF Investor.