China or India?
Oil and gas or alternative energy?
Semiconductors or nanotechnology?
Pick an economic sector to lead the next economic cycle, pick a region or pick a country. Whatever choice you make, there's almost certainly an exchange-traded fund to use as an investing vehicle.
ETFs are index funds that trade like stocks. They're cheap to own, transparent in telling you what stocks or bonds they hold and infinitely flexible in terms of building portfolios. Here's how to put them to work in harnessing whatever sectors, regions or countries you believe will lead the next market surge.
Step One: Scan your current holdings
If you see potential for a conventional sector like financials, energy or base metals to surge, then you may not need to do anything to prepare your portfolio. That's because these sectors are amply represented in broad-based Canadian equity mutual fund and ETFs. Financials are the top sector in the S&P/TSX composite index right now at about 30 per cent, so any rebound in banks and insurers will be felt if you own a broad market ETF. Energy is next at about 27 per cent, while materials follow at 17 per cent.
Step Two: Find ETFs that track your favoured sectors
There are more than 850 ETFs listed on North American exchanges, and new ones are coming to market regularly. So you've got some work ahead to locate funds that will track a given sector, region or country.
There are 108 ETFs listed on the Toronto Stock Exchange, which is a manageable number to sift through using the filter here on Globe Investor. For the 700-plus ETFs listed on the New York Stock Exchange, go to the NYSE website and its handy detailed ETF screening tool.
Thinking of China as a leader for the next global economic upswing? The NYSE screener shows six possibilities in the "China region" category. Thinking of alternative energy? Type the phrase "energy" into the screener's search box and you'll find close to a dozen wind power, solar power, clean energy and alternative energy choices intermingled with traditional oil and gas ETFs.
Step Three: Narrow down the possibilities
Where there's a promising sector, there's going to be multiple ETF choices from competing companies. Here are some criteria to help you decide which one is suitable for your needs:
- Fees: The lower, the better.
- Liquidity: Investors have clear favourites in all ETF categories, and you can track this by looking at daily trading volumes; avoid orphan ETFs that trade in small amounts.
- The underlying index: Ideally, it will be maintained by a well known indexing firm, be well diversified (by both sector and individual stocks) and use a clear, sensible methodology.
- Returns: Check results in the last bull market, and in the current bear market.
Step Four: Mind the risks
A general rule of investing is that risk expands as you get narrower in the sector or geographic region you're buying into. For that reason, a portfolio weighting of 5 per cent is sensible for a sector-specific ETF.
Currency risk is another factor. There are a few sector ETFs traded on the TSX, but the vast majority are U.S.-listed. If the Canadian dollar rises against the U.S. buck, and many observers think this can happen when the global economic crisis subsides, then the value of U.S.-listed ETFs will be eroded no matter what happens with their market price. Currency fluctuations are a major concern in the short term, but they tend to wash out if you hold on for long periods of a decade or more. Note: Some ETFs with global exposure come in versions that use hedging to eliminate the impact of currency moves.
Step Five: Have a plan
A lesson taught by the bear market is that it's potentially ruinous not to have a pre-determined exit point for your speculative investments. You can buy blue-chip funds or stocks and hold on, but sector investments are vulnerable to huge declines that should avoided if at all possible.
So monitor your sector ETFs closely as the next economic boom develops. Be ready to purge any duds, and to take profits after a nice run-up.
Rob Carrick