As the end of the year approaches, financial advisors are busily putting the finishing touches on portfolios that will carry clients into 2013. Five prominent ETF investment managers spoke with Financial Advisor to discuss the year ahead—to talk about how they are positioning assets, what their outlook for the economy and financial markets is, which ETFs will best weather a tepid economic recovery and which ones will add pizzazz to investor portfolios.

David D’Amico
Braver Wealth Management

On his outlook and portfolio positioning: “If I had to guess whether or not the stock market will be higher at this time next year, I’d have to say higher,” says D’Amico. He believes a number of factors, including historically low interest rates, favor equities over fixed-income right now. Compared with the earnings yield on stocks (earnings per share divided by stock price), bond yields look especially paltry. He expects the halting pace of the U.S. economic expansion to continue, although Europe’s continuing debt woes are likely to make a global recovery a gradual, multiyear process.

Since the beginning of the year, the bond allocations in his moderate portfolios have dropped about 10 percentage points, from 35% of assets to their current level of 25%. Most of that money has gone into large-cap U.S. equity ETFs, as well as tactical mutual funds that move back and forth from stocks into cash. About 5% to 10% of his assets are in commodity investments.

On ETFs for 2013: The quality of loan portfolios are improving and stock valuations have become reasonable, so D’Amico views ETFs such as the Financial Select Sector SPDR fund (XLF) and the SPDR S&P Regional Banking fund (KRE) as good sector recovery plays. The latter, which focuses on small and mid-cap banks, should benefit as the pace of mergers and acquisitions among those institutions picks up. Meanwhile, an ETF that tracks shares of gold miners, the Market Vectors Gold Miners fund (GDX), represents a good value because the stocks are trading at a significant discount to where they normally trade relative to the price of gold.

His portfolios are also overweight in the technology sector, where he invests through the Technology Select Sector SPDR fund (XLK). D’Amico likes the strong balance sheets and attractive valuations of the index’s component companies, which include Apple, Microsoft, Google and AT&T.

Steve Gluckstein
President Seaview Global Advisors

On his outlook and portfolio positioning: Gluckstein views the current environment as “a deer in the headlights moment for the economy.” He fears that unless the “fiscal cliff” is dealt with quickly, we could see weaker-than-expected economic growth in the first half of 2013. Given the uncertainty about economic and tax policy, he thinks it’s likely that stock market volatility will rise next year.

His firm’s portfolios reflect Gluckstein’s cautious view. At the beginning of the year, the moderate portfolios had about 60% of their assets in equities. Now, that allocation is down to 45%, with most of that in large-company U.S. equity ETFs. Much of the money the firm removed from the stock market earlier this year remains in cash. The firm also had some exposure to European stocks at the beginning of 2012, but cut back those positions significantly in April and May. “The European Central Bank has voiced its support of the euro and the bailout of Spanish banks, but the actual money has yet to change hands,” he says. “The situation there is not likely to be rectified soon.”

On ETFs for 2013: “Some suggest the game for high-yield bonds is over, but I disagree,” says Gluckstein. “Balance sheets are the healthiest they’ve been in a long time, and low bond rates are a favorable scenario for the high-yield market.” Gluckstein uses two broad-based U.S. high-yield ETFs: the SPDR Barclays Capital High Yield Bond fund (JNK) and the iShares iBoxx High Yield Corporate Bond fund (HYG). In addition, he uses the Market Vectors International High Yield Bond fund (IHY) for pure international exposure to the sector.

He also believes that with new leadership in place, China will introduce more measures to stimulate its economy and that consumers there will respond by increasing spending. “China has lagged the global markets over the last few years, but the conditions for 2013 set the table for relative outperformance,” he says. Two ETFs he believes will benefit are the iShares FTSE China 25 fund (FXI), which covers large caps, and the Powershares Golden Dragon China fund (PGJ), which zeros in on midsize companies.

Vern Sumnicht
Sumnicht & Associates

On his outlook and portfolio positioning: Of the investment managers interviewed for this article, Sumnicht is the one most concerned about inflation. “When countries get into a situation where they’ve become irresponsible with debt, they either default, as Iceland did, or they print more money. The U.S. government is printing more money to service its mounting debt, and historically that has led to inflation. The process could take years, but we’ll absolutely see the beginning of it in 2013 or 2014.”

In that case, says Sumnicht, “hard” assets such as precious metals and real estate will outperform other asset classes. In his moderate portfolios, he has about 10% of assets devoted to precious metal ETFs and another 20% in other “real asset” investments such as REIT ETFs. Because bonds will do poorly in a rising rate environment, the firm’s fixed-income allocation has a duration of just one year, with a heavy emphasis on short-term corporate and government securities and adjustable-rate notes.

On ETFs for 2013: The Guggenheim Timber ETF fund (CUT) and the iShares Dow Jones U.S. Real Estate fund (IYR) should both benefit from a continued pickup in the housing market and construction, he thinks. The SPDR Gold Trust fund (GLD) and the iShares Silver Trust fund (SLV), meanwhile, would have the wind at their backs in an inflationary environment. And the SPDR Barclays Short-Term High Yield Bond fund (SJNK) can tap attractive yields in the high-yield debt market with less interest rate risk than longer-term bonds.

Tyler Mordy
Director of Research
Hahn Investments

On his outlook and portfolio positioning: When it comes to economic growth and stability, Tyler Mordy sees a continuation of the trend toward a “bifurcated world.” On one side are the U.S. and other developed world economies whose economic growth is stymied by high levels of government debt and sluggish growth in tax revenue. “This environment argues for slower growth, higher market volatility and more frequent lapses into recession,” he says. On the other side are emerging markets whose economies are still in an expansion phase. “These emerging markets are increasingly becoming the global centers for growth and stability, though their financial markets are still relatively immature.”

With the credit quality of emerging market countries moving up the ladder, emerging market bonds offer a good higher-yielding alternative to U.S. government bonds. Mordy characterizes U.S. stocks as “not cheap, but not expensive,” and believes that high-quality stocks with healthy dividend yields, such as those in the health-care and consumer staples sectors, will outperform the market in the coming year. “Investors are looking more at dividends and share buybacks, and less at rapid earnings growth,” he says. “These days, cash flow is king.”

On ETFs for 2013: He is interested in biotech companies, which should benefit from several trends: an aging population, innovations in new products and the opportunities these companies will see to be acquired by pharmaceutical giants. These trends bode well for a biotech ETF like the SPDR S&P Biotech fund (XBI). He is also interested in gold. He says the Market Vectors Gold Miners fund (GDX) is a cheaper way to follow the price of gold than traditional gold ETFs.

To generate income, Mordy looks to a mortgage REIT, the Market Vectors Mortgage REIT fund (MORT), which had a 30-day SEC yield of 11.81% as of September 30. Still, this fund’s underlying securities carry prepayment risk.

To tap higher yields and increasing economic stability in emerging market countries such as Brazil, Chile, Peru and Poland, he uses the WisdomTree Emerging Markets Local Debt fund (ELD).

Paul De Rosa
Gateway Advisory

On his outlook and portfolio positioning: Paul De Rosa believes that the dichotomy between sluggish economic growth and the strong stock market that characterized most of 2012 will continue into 2013. “We’re very optimistic about stocks, particularly U.S. large caps,” he says. “Right now, our relative strength signs are pointing in a positive direction. Unless there’s a big move to the downside by the end of the year, it looks like we’ll be going into 2013 almost fully invested.”

That wasn’t the case going into 2012. De Rosa allocates assets based on their attractiveness relative to each other and to risk-free assets such as Treasury bills. In January, about 90% of the growth model portfolio was in cash equivalents. But he moved back into the markets during the year as they showed signs of increasing stability, and by the end of October, the growth portfolio had 40% of assets in U.S. stocks, 35% in international equities and the rest in a mix of bonds, commodities, currency-related investments, real estate and cash.

On ETFs for 2013: De Rosa points to the IQ Real Return fund (CPI) as a good way to address concerns about inflation on bond portfolios. He says this ETF, designed to provide a return above the rate of inflation, “is a good complement or substitute for short-term bond holdings because of its low volatility and potential for capital appreciation.” 

He also likes the IQ Hedge Multi-Strategy Tracker fund (QAI), which attempts to replicate the performance characteristics of hedge funds using approaches like long/short and market-neutral investing. The ETF “has about the same volatility as an intermediate-term bond portfolio, but with better upside potential,” he says.