It’s hard to find exchange-traded funds that beat the U.S. stock markets last year. But there are plenty that fell behind, some by a significant margin.

Precious metals and other commodity ETFs struggled, as did those following China, Brazil, India and other emerging markets. While developed markets in Europe and Japan got a decent boost in 2013, they have yet to catch up with the U.S. market’s meteoric rise since 2009.

With the long bull run in U.S. stocks, warnings about overvaluation have become more common. Noteworthy market watchers raising a red flag include Nobel prize-winning economist Robert Shiller, who sees a rise in his cyclically adjusted price-to-earnings ratio as a sign that the market could be overheating. S&P Capital IQ chief equity strategist Sam Stovall sees the possibility of a significant pullback of 10% or more in major U.S. indexes before the market ends the year slightly higher.

While few are predicting an all-out bear market for U.S. stocks, or suggest abandoning them altogether, some investment managers are finding less pricey places to invest that they believe could outperform the broader U.S. market over the next few years. “U.S. equities have been the investment to beat,” says David Hanna, senior vice president at Boston Advisors. “But that leadership position is probably drawing to a close.”

Below, Hanna and other investment managers who specialize in ETF portfolios pinpoint some of last year’s laggards that they believe could beat the U.S. market in 2014 and beyond.

Andrew Zimmerman, Co-founder and Chief Investment Strategist
DT Investment Partners
Zimmerman believes the Japanese market will continue to get a lift from the new policies of Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda, who have taken steps to kick-start the country’s stalled growth engine after over 15 years of deflation. With Japanese consumers starting to snap up more high-end goods and with prices ticking up, the government’s goal of raising inflation to 2% by 2015 is within sight. “Abenomics is working,” Zimmerman observes. “It’s good for the economy and it’s going to be good for the stock market.”

Despite high unemployment and slow economic growth, he believes the European stock market will also do better than the U.S. this year. “Based on corporate fundamentals, it appears likely earnings will increase at a decent rate. Price-earnings ratios are still 35% below 2007 highs. And I think the bad news about the economy has already been baked into the numbers.”

In Zimmerman’s view, emerging markets could be the “comeback kids” of 2014. After last year’s selloff, diversified emerging market ETFs are priced at an attractive 13 to 14 times earnings. Zimmerman is particularly drawn to China. “The country is moving toward capitalism as state-run monopolies become independent businesses,” he says. “The population is younger, and the country has a lot less debt than the U.S.”

DT Investment Partners uses the iShares MSCI Japan (EWJ) ETF for Japanese exposure. Another ETF the firm owns, WisdomTree Hedged Japan (DXJ), uses currency hedges to minimize the impact of currency fluctuation on share price and got a boost last year when the yen fell against the dollar. In Europe, Vanguard’s FTSE Europe ETF (VGK) provides a low-cost, liquid entry point to that market. The iShares Large Cap China (FXI) fund is “the most liquid way to play the large-cap Chinese market,” while MSCI South Korea (EWY) provides access to a trading partner with a heavy stake in the Chinese economy.

Vern Sumnicht, CEO
iSectors
Vern Sumnicht isn’t sure whether 2014 is going to be a strong comeback year for gold and other precious metals. But he believes that at current prices they are likely to outperform the S&P 500 index over the long term.

“Ten years from now, I think we’ll see that precious metals outperformed the S&P 500 index,” he observes. “From a long-term perspective, now is not a bad time to buy.”

Between the end of 2000 and 2012, the price of gold rose from $272 an ounce to over $1,600 an ounce. By the end of 2013, gold stood at about $1,200 an ounce, making it the first calendar year since 2000 that the metal ended the year lower than it began. Sumnicht says that while gold and precious metals prices could fall further, “a long-term trend of rising interest rates and rising inflation makes them a good bet for no more than 10% of someone’s portfolio.”

Despite a positive longer-term outlook, Sumnicht’s firm sold all of its positions in its gold and silver ETFs in December and moved the money into the Central Fund of Canada (CEF), a closed-end precious metals fund. The move allowed clients with taxable accounts to bank capital losses from the ETFs for tax purposes.

While it keeps a fairly low profile in the U.S., the Central Fund of Canada has average daily trading volume of more than 850,000 shares a day and is the largest closed-end fund in existence. It invests in gold and silver bullion in roughly equal proportions, and its price tracks those metals fairly closely. The kicker is that when precious metal prices drop, its share price can fall more dramatically than its net asset value. The difference gives investors the opportunity to “buy bullion at a discount,” says Sumnicht. Last year, the closed-end fund share’s discount to net asset value peaked at 8.5%, according to Morningstar.

Sumnicht also likes prospects for emerging markets. In addition to traditional market-cap-weighted ETFs in the sector, he also owns WisdomTree Emerging Market Equity Income (DEM) “to get a little more diversity.” The ETF differs from traditional market-cap-weighted indexes because it weights its holdings based on screens for high-quality emerging market stocks with the highest dividends. A price-earnings ratio of 10, compared to 13 for Vanguard FTSE Emerging Markets (VWO), reflects a stronger value tilt. Another firm holding, WisdomTree Emerging Market Small Cap Dividend (DGS), uses a similar methodology to access high-quality smaller companies.

David Hanna, Senior Vice-President and Director of Research and Alternative Investments
Boston Advisors
Of all the commodities that lost ground in 2013, Hanna believes platinum offers the best shot at appreciation over the next few years. “It’s harder to make a case for gold or silver,” he says. “The movements behind them are based too much on emotion.”

Like gold and silver, platinum is used for jewelry. But its application as an industrial metal, particularly for the automobile industry, provides a tailwind when automobile sales are rising. According to Hanna, there is room for growth on both fronts. “Twenty-five percent of the demand for platinum is coming from the rapidly growing Chinese market. Sixteen percent comes from the European auto sector, which is seeing a nice rebound.” To play the platinum theme, the firm uses ETFS Physical Platinum Shares (PPLT). Structured as a grantor trust, the ETF is backed by platinum bullion stored in vaults in London and Zurich.

Hanna also likes prospects for emerging markets. His firm uses EG Shares Emerging Market Consumer (ECON) as a complement to its core holding in Vanguard FTSE Emerging Markets. The EG Shares ETF, which owns 30 large-cap consumer companies domiciled in emerging markets, provides direct exposure to well-established companies that serve the growing middle class in those regions. Many consumers in those areas prefer well-known local brands to those from developed markets, and almost all of the revenue of these companies comes from emerging market sales. The fund is less China-heavy than ETFs based on the MSCI Emerging Market Index or similar benchmarks, and has a greater presence in “frontier” regions such as Mexico or South Africa.

Larry Whistler, President and Chief Investment Officer
Nottingham Advisors
“International developed markets lagged the U.S. a lot in 2013, but we’re looking for better relative performance in 2014,” says Whistler. “The Asia/Pacific region and Europe are catching up in the economic recovery process, and the valuations in those markets are still quite attractive. That leaves plenty of room to catch up with the U.S.” While Whistler thinks the U.S. market could edge up 10% to 12% in 2014, he anticipates returns of “15% or better” for established foreign markets.

The firm zeros in on the sector mainly through iShares Core MSCI EAFE (IEFA), a broad basket of developed market companies in Europe, Asia and Australia. For a more focused tactical recovery play, the firm turns to iShares MSCI Spain Capped (EWP). “Spain has certainly gone through some tough times, but we’re starting to see signs of economic recovery and reduced stress on the financial system,” he says. “We think the bad news has already been priced into that market.” At 45% of assets, financial services stocks represent the largest sector weighting.

Although energy stocks did relatively well in 2013, Whistler believes the oil services industry has the potential to outperform the broad U.S. market in 2014. “With the drop in oil prices, investor expectations are low, but I believe there could be some decent upside surprises in 2014 as Mexico and Iran open up drilling.” To play that theme, the firm uses Market Vectors Oil Services Trust (OIH), which invests in the world’s 25 largest companies in the oil services industry.