November 11, 2013 at 14:51 PM EST
How To Add Alpha Using Tactical ETFs
NASDAQ:IBB, NYSEARCA:UUP, NYSEARCA:FXE, NYSEARCA:XLP Related posts: Exchange Traded Concepts Files For Hull Tactical US ETF Stay Tactical Until More Clarity Develops First Trust Announces Launch of First Trust Global Tactical Commodity Strategy Fund First Trust To Begin Trading The First Trust Global Tactical Commodity Strategy Fund (NASDAQ:FTGC) IndexIQ’s IQ Alpha Hedge Strategy Fund, First Open-End Mutual Fund Based on Hedge Fund Replication

etfsDavid Fabian: Constructing a well balanced portfolio takes time, tools, and discipline in order to implement a plan that will meet your goals.  My preferred investment vehicle to construct a diversified portfolio is through exchange-traded funds.  I love ETFs because they are low cost, transparent, liquid, and easy to trade.  In addition, they allow you the ability to set automatic stop losses as a function of managing risk and have greater flexibility than a traditional mutual fund.

As I wrote several months ago, the first step in this process is selecting core holdings that will be the foundation from which you can ultimately expand upon.  These core positions will give you broad-based exposure and directional bias in the market to keep pace with rising stock prices.  However, a core position will only take you so far.  Ultimately getting exposure to specific sectors or tactical trading ideas will shape your portfolio to your specific investment preference.

Tactical positions represent a sector, industry group, or special situation that you want to take advantage of.  Often times these positions start out as short-term trades that can turn into long-term investment themes.  They give you a measure of overweight exposure towards a certain area of the market that you feel is offering excellent potential for capital appreciation.

I typically recommend that you allocate anywhere between 20-30% of your portfolio towards tactical ETF opportunities and keep a measure of cash on hand for new themes that may present themselves.  That way you can actively shift your holdings to take advantage of new trends or capitalize on an innovative strategy when the timing is right.  In addition, I always recommend pairing new trades with a sell discipline to guard against the potential of a reversal.

Now let’s take a look at some of the different types of tactical ETF opportunities:

Sectors

One of the easiest ways to add instant tactical exposure to your portfolio is to select a sector fund.  By owning an ETF that only invests in technology or healthcare stocks you can get pinpoint exposure to a group of companies that are in a similar economic segment.  I recently profiled how Fidelity launched 10 sector ETFs which are the cheapest in the industry when compared to larger and more well-established competitors.

The largest and most well-known sector funds are the SPDR ETFs which are sponsored by State Street (STT).  These widely tracked ETFs are often referenced by experts as a benchmark for their respective categories.  However, that doesn’t necessarily make them the best option for your portfolio.  A comparison between the Consumer Staples Select Sector SPDR (XLP) and the First Trust Consumer Staples AlphaDEX Fund (FXG) shows that FXG has outperformed its peer by over 18% in the last year.

Remember that when selecting an ETF, you should compare the underlying index construction, holdings, and fees to determine what might be best suited for your needs.  In this example, FXG benefits from a unique index construction methodology with an outsized bias towards mid-cap stocks which has been an excellent alpha creator over the benchmark.

Industry Groups

Slicing the markets down even further leads us to industry groups, which give you even more concentrated exposure to a select group of similar companies.  Some great examples include biotechnology or solar stocks which have both had fantastic moves in 2013.  Two ways to play these industries include the iShares NASDAQ Biotechnology ETF (IBB) and the Guggenheim Solar ETF (TAN).  These ETFs have gained approximately 44% and 147% year-to-date respectively as November 7.

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Related posts:

  1. Exchange Traded Concepts Files For Hull Tactical US ETF
  2. Stay Tactical Until More Clarity Develops
  3. First Trust Announces Launch of First Trust Global Tactical Commodity Strategy Fund
  4. First Trust To Begin Trading The First Trust Global Tactical Commodity Strategy Fund (NASDAQ:FTGC)
  5. IndexIQ’s IQ Alpha Hedge Strategy Fund, First Open-End Mutual Fund Based on Hedge Fund Replication

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