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ETF Specialist

ETFs for the New Presidency

We hail the new chief with these ETF ideas.

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Although a definite uncertainty gap exists between policy initiatives and future reality, when considering investments, it is worth paying attention to the politics of a new president and the policies he plans on pushing. With that in mind, we polled the Morningstar ETF team to find the best investment themes for the new administration and the best ETFs to take advantage of those themes.

Natural Gas
President Obama plans on providing billions of dollars for incentives toward clean energy development that would help America secure energy independence, but achieving such a lofty goal is decades away. We believe that many investors are speculating that an Obama administration translates into immediate incentives to solar and wind power development, with ETFs such as  First Trust Global Wind Energy (FAN), Claymore/MAC Global Solar Energy (TAN), and  PowerShares Global Wind Energy (PWND) being prime beneficiaries. We are a bit skeptical. Economics still matter, and the cost of alternative energy sources is still too high when compared with the tried-and-true alternatives, even when subsidies are considered.

Utilities have scaled back their capital spending programs dramatically in the face of the current credit crisis, and the recent pullback in commodity prices is bringing down the price of electricity across the country. As exit polling suggested, the economy is by far the most pressing issue to voters. To optimize our capital resources over the next five years, we anticipate that any growth in electricity demand will be met by existing idle power plants that are fueled by natural gas. Natural gas plants account for roughly 50% of the nation's generating capacity yet produce only about 19% of power consumed. Employing these assets in the near term is pragmatic in that we produce most of the natural gas we consume, there is no additional fixed-cost investment in the near term, and natural gas generation emits much less carbon dioxide than a comparable coal facility.

The financial crisis is forcing oil and gas companies to cut their drilling projects dramatically, so near-term supply growth will likely slow dramatically. With natural gas-fired electricity output continuing to grow at over 4% per year--even as electricity production growth has slowed--demand could very quickly outpace supply. Thus, buying a fund that is speculating solely on the price of natural gas, like  United States Natural Gas (UNG), could prove to be a wise tactical move. Those with a bit more risk tolerance could focus on the companies that would benefit from natural gas price appreciation by purchasing  iShares Dow Jones US Oil & Gas E&P (IEO), but such an investment could be subject to lower earnings growth from lower production volumes.
Paul Justice

Health Care
Interest in the health-care sector has mounted in anticipation of the new administration's arrival to the White House. Although it remains to be seen exactly what impact new regulation and policy measures will have on the stocks in the sector, we do know one thing: Change is coming. But let's not go overboard--the likelihood of a nationalized health-care system is slim to none, in our view. So who are the winners and losers in the sector?

Unfortunately there's no clear answer. We see some offsetting factors that could impact certain health-care firms, considering the limited information we have gleaned from potential new policies. First, if the 46 million Americans who are currently uninsured gain better access to health care, then it would be safe to assume that volumes, in general, would pick up across the industry. However, the issue under fire is pricing. With a mandate for making health care more affordable and accessible, we could see regulations that might squeeze profitability for a whole slew of managed-care and other health-care providers.

With a great amount of uncertainty surrounding just how things will play out, we think a broad sector ETF makes the most sense for individual investors. For example, with either the  Health Care Select Sector SPDR (XLV) or the  Vanguard Health Care ETF (VHT), investors will enjoy broad exposure to the sector (at a very low cost) without being exposed to stock or industry-specific risk. Under the hood of both of these ETFs investors will find roughly two thirds of assets tied to pharmaceutical and biotechnology firms, with the remaining third of assets allocated to medical equipment and services. Our favorite of the bunch, however--despite its steeper expense ratio--is  iShares S&P Global Healthcare Sector (IXJ), which is weighted more heavily in pharmaceutical stocks. We don't mind paying a slight premium in order to gain exposure to the promising pipelines of global drugmakers such as  Novartis (NVS),  GlaxoSmithKline (GSK), and  Sanofi-Aventis (SNY).
John Gabriel

Municipal Bonds
President Obama's tax plans were one of the key platforms that he championed. A main part of that platform was his plan to raise taxes on those investors making more than $200,000 a year (or $150,000, or $250,000; there seemed to be some disagreement on the actual number). The current financial crisis may have changed these plans for the time being, but Democratic members of Congress have made it clear that this issue has been only temporarily put on the back burner.

If you find yourself in that taxable income bracket, it might do you well to consider investing in municipal bonds. Municipal bonds have extra value to high-income investors because the income stream received from them is shielded from income taxes. If your tax rate goes higher, the residual amount remaining after Uncle Sam has had his share shrinks on interest payments from a Treasury or corporate bond that you hold in a taxable account.

Now, munis are not immune from the credit malady () that has swept the nation. Municipalities rely on real estate taxes and sales taxes to support these debt payments, and many municipalities' balance sheets aren't in the best shape. We are particularly concerned with issuances from such hard-hit states as California, Ohio, Arizona, Florida, and New York. Still, these bonds are trading at steep discounts, and there are deals to be found.

Our recommendation in the space is a fund that provides two layers of protection: PowerShares Insured National Muni Bond ETF (PZA). The fund is a representative sampling of 63 issues from across the country--although it does contain issues from the aforementioned states. Still, the broad diversification will help avoid the disastrous consequences of any one issue defaulting on its obligations. In addition to the diversification benefit, this fund is also insured, which means that should any one of the issuers get tripped up, a municipal bond insurer will make good on the principal.
Scott Burns

A version of this article originally appeared Nov. 7, 2008.

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Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

Scott Burns does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.