ETF Portfolio Ideas for the Year Ahead

As ETF investors review their holdings for the year ahead, there are various considerations to build a well diversified investment portfolio.

On the recent webcast (available on demand for CE Credit), How to Build a Long-Term, Low-Cost Portfolio, Matthew Bartolini, Head of SPDR Americas Research at State Street Global Advisors, pointed out that in the ETF space, the fixed-income category is growing in popularity despite the great year for equity ETFs, reflecting the ongoing demand for income-generating assets. Specifically, while equity flows nominally outpaced those of fixed income, bond funds saw assets expand by 26%, compared to only 10% growth in equity assets under management.

Meanwhile, the Federal Reserve’s monetary tightening plans have pushed the short end higher while long yields have dipped as growth and inflation expectations remain muted.

“We expect one, maybe two, rate hikes next year. With the long-end of the yield curve held down by low inflation and high demand for Treasuries, the Fed doesn’t have much room to move. Fundamentals suggest that the economy continues steady growth until the Fed ends the business cycle by tightening too much,” Gary Stringer, CFA, President and Chief Investment Officer of Stringer Asset Management, said.

Among the various market factors in play, momentum has been the top performing factor over the past three years, especially this year, but value and yield have underperformed. The muted performance in these value plays may be partially attributed to the depressed volatility across asset classes, with traditionally higher risk assets experiencing the largest relative reductions. However, the value, dividend, quality and minimum volatility factors remain among the most popular style picks among investors.

Investors should also consider potential risks in an extended bull market environment. Bartolini warned that historically, forward 12 month returns are capped when the market price-to-earnings is elevated, which may potentially indicate lower 2018 returns ahead. Looking at data since 1954, forward 12-month returns have been -1.3% based on market P/E of 21x.

Stringer, though, anticipates that the bullish conditions in the U.S. may continue as a strengthening economy keeps chugging along. Stringer projects real GDP growth for the rest of 2017 and 2018 should hover around 2.0% to 2.5% at a 2.0% inflation rate. Current signals suggest an uptick in economic activity into next year on increased consumer spending and business investment, which should translate over to rising potential for corporate revenue and earnings growth.

As investors consider portfolio allocations, Stringer suggests people should establish an expense budget or save on broad, cheap core positions so one can spend on more esoteric ideas. For example, Stringer favors current themes like small- and mid-cap, along with high quality corporate debt as core ideas. ETF investors can track these areas with options like SPDR Portfolio Mid Cap ETF (NYSEArca: SPMD), which has a 0.05% expense ratio, and SPDR Portfolio Intermediate Term Corporate Bond ETF (NYSEArca: SPIB), which has a 0.07% expense ratio.

On the other hand, investors may also consider opportunities in overseas markets. Broad developed ex-U.S. equities, including key regioanl sub-sets, are trading near or below their 10th percentile price-to-book relative to the U.S.

Beyond valuations, international fundamentals also look strong. For the first time since the financial crisis, the economies of all 45 countries tracked by the OECD are expected to grow, with 33 countries anticipated to see growth rates accelerate, the highest number since 2010.

Bryan Novak, CAIA, Senior Managing Director of Astor Investment Management, pointed out that the Eurozone economy has seen accelerated expansion, and China, the second largest economy in the world, moderated in the first half and appears to have stabilized. Overall, Novak argued that low interest rates globally still support risk premiums in global equities. Looking ahead, he pointed to a diverse market segment exposure for portfolio allocations, with an increased focus on international exposure.

Investors interested in a cheap and diversified international ETF option may consider something like the SPDR Portfolio World ex-US ETF (NYSEArca: SPDW), which has a 0.04% expense ratio, for broad international exposure or something like the SPDR Portfolio Emerging Markets ETF (NYSEArca: SPEM), which has a 0.11% expense ratio, for a cheap emerging market position.

Financial advisors who are interested in learning more about low-cost portfolio construction can watch the webcast here on demand.