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| The Basics | Play the market like a hedge-fund pro
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Hedge fund managers use exchange-traded funds to take advantage of short-term moves up or down. So can you, with help from MSN Money's new ETF Center.
By Harry Domash
Hedge funds are all the rage these days, primarily because they've built a reputation for making money as the market goes sideways or even down. Hedge-fund managers are not buy-and-hold investors. Instead, they specialize in making fast trades to take advantage of short-term market moves.
And despite their reputation for using exotic investments to do their handiwork, hedge-fund managers are heavy users of one tool -- exchange-traded funds, or simply ETFs -- that are readily available to smaller investors.
ETFs are portfolios of stocks that replicate the performance of just about every imaginable stock index. You can use them to quickly bet on, or against, various industry sectors, something that wouldn't be practical if you had to research and take positions in individual stocks. ETFs trade just like stocks, and you pay the same commissions for trading them as you would any stock.
Hedge-fund managers find ETFs especially useful because they can short them, meaning that they can use them to bet that an industry or market sector is about to drop.
Since most ETFs require no minimum investment, there's no reason individual investors can't use them to time the market, or particular areas of the market, just like hedge funds.
ETFs for every reason
ETFs give you almost unlimited flexibility. If you think Europe is a better play than the U.S., ETFs give you a way to act on that hunch. If you'd rather fine-tune your strategy to individual countries -- say you think that Spain is the place to be -- you can do that too.
Within the U.S., you can use ETFs to invest with, or against, broad categories such as large growth, small-cap value or just about every imaginable combination of company size and valuation. | Short selling | | Short selling involves selling shares that you don't own in the hope that you can buy them back at a lower price later. You make money if the share price drops during the period that you're short, and you lose money if they go up. |
You can also use ETFs to invest in specific industries or sectors, including: biotech, energy, financial services, health care, Internet, pharmaceuticals, real estate, technology and transportation.
If you want to play the commodities market, gold and precious metals ETFs are available now and oil is on the way.
Here are some ideas for using ETFs to do what hedge funds do; that is, play a market segment such as small-cap growth, or a sector or industry, that you think is heading up or down.
One caveat: Making market or sector bets requires a different mindset.
Usually, you use past performance to evaluate mutual funds, and to some extent individual stocks. However, with sector investing, you're looking for a change from the past: Either a strong sector that is weakening or a laggard showing signs of life.
For example, some money managers say that the large pharmaceuticals makers such as Merck (MRK, news, msgs) and Pfizer (PFE, news, msgs), which have underperformed for a long time, are undervalued by all measures and due for a bounce. If you buy that story, you'd likely find that the Pharmaceutical Holders (PPH, news, msgs), which holds all the big name pharmas, is your best play.
Related news and commentary on MSN Money
You shouldn't be dissuaded by its 3% average annual loss over the past five years. That's why the sector is undervalued.
Finding industries by evaluating stocks
How do you know which market segments, economic sectors or industries are likely to outperform or underperform?
Nobody knows for sure, of course. But MSN's StockScouter predicts, based on its quantitative analysis of recent stock performance, which industries, what size companies and what investment styles are likely to outperform or underperform over the next one to two months.
You can find the StockScouter In/Out of Favor list on the Market Statistics menu in the Markets section. From the top navigation of this page, click Markets under Investing.
The best of industries, the worst of ...
Industry trends usually continue for several months, so MSN's list of the past month's 10 Best and 10 Worst Performing Industries should give you some ideas. When I looked, semiconductors and Internet service providers were the biggest winners while agricultural chemicals and aluminum makers were the biggest recent losers.
You can find the Best and Worst Performing Industries by clicking on "Industry Winners/Losers" in the Lists and Trends section of Market Statistics.
Changing forecasts
Since earnings forecast changes move stock prices, tracking analysts' earnings forecast changes for stocks making up an industry is another way to get a handle on which industries are gaining and losing strength. Here's a link to an article describing my ideas on how to do that.
The human touch
In my view, keeping up with how economic news is moving stock prices is the best way to get a longer view on which industries and sectors are gaining and losing strength. Briefing.com's end-of-day market events summary puts each day's market action into context, especially in terms of which industries and sectors are gaining or losing strength. The report can be lengthy, so if you're too busy to read it, Briefing.com's Sector Watch at the top of the page summarizes the day's action in terms of strong and weak industries and sectors.
Finding the right ETF
After you've identified an area of interest such as an industry, market capitalization or investing style, click on "A Complete List of ETFs" in MSN Money's ETF Center to see a list of all ETFs. Focusing on the "Investment objective" column, scroll to the section of interest, for instance, mid-cap value or semiconductors.
Once you have a list of candidates, read the overview in each ETF's Snapshot report and its top 10 holdings and sector distribution (Top Holdings report) to see if any of your candidate's holdings are more representative of the industry or investing style you are trying to replicate than the others. Often, you'll find that competing ETFs have similar portfolios. If that's the case, pick the ETF with the lowest expense ratio, as listed in the snapshots.
Timing the markets with ETFs, though, isn't just about establishing long or short positions. With short-term trading, you also have to know when to close out your positions. Review the StockScouter, Best/Worst Industries and Briefing.com's Market reports regularly and be alert to signs that market sentiment is going against you.
At the time of publication, Harry Domash did not own or control any of the securities mentioned in this article.
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