Related Resources Screen for the best stocks for you See how MSN Moneys StockScouter rates a stock Find out today's big trends Jubak's Journal Recent articles: • Jubak: 5 stocks the market's set to love, 4/21/2004 • 10 winning stocks for a stuck-in-a-rut market, 4/20/2004 • How to profit in a stuck-in-a-rut market, 4/16/2004 More... | Jubak's Journal My 5-step guide to ETFs Exchange-traded funds -- little slices of a sector that trade like a stock -- can be a great hedge against market volatility. But not all ETFs will work. By Jim Jubak A risky, volatile market isnt the best time to go to school on new investing strategies; the tuition is too high. But volatility can be the grizzled investors friend. Todays column, then, is for investors who have mastered turning the markets volatility into profits. And if youre not as seasoned an investor as youd like to be, this column will introduce you to some new investing concepts that can help build a long-term trading strategy. Thanks to exchange-traded funds, or ETFs, the average investor, even the average small investor, has far more alternatives than ever before for hedging risk and even for profiting from a down market. These baskets of stocks, often based on widely followed indexes such as the Nasdaq 100 ($NDX.X) or the Standard & Poors 500 ($INX), give investors a low-cost way to quickly make massive buys and sells of entire stock market sectors or industry groups at, potentially, low cost. Because ETFs are baskets of stocks, rather than mutual funds, investors can sell them short. Thats a time-honored way, if often reviled and certainly complicated, to make money in a falling market. (In short selling, a trader borrows stock, usually from a broker, sells it and then buys it back when the stock, theoretically at least, declines in price. Then, he returns it to the original owner.) And, finally, because ETFs are baskets of stocks, rather than single stocks, these instruments do take some of the worst complications out of short-selling.
I cant possibly review all the ETFs now on the market. (There are at least 126 ETFs today.) And Im not here to give you a primer on short-selling in this column, even if I were experienced enough in selling short to do that. What I can do, however, is mention some of the ETFs best suited to hedging in this market and offer some general rules to use when evaluating these instruments. So, call what follows My 5-step guide to ETFs. I dont pretend its all you need, but I hope it provides a good place to start for thinking about these new investing tools. ETFs track an index Like the more familiar stock index mutual fund, such as the Vanguard 500 Index (VFINX), an ETF is designed to track a specific index. But since the first ETF was launched in 1993, theyve proliferated to offer a choice for all the better-known stock indexes, most of the obscure indexes and, in some cases, sector and industry indexes invented just for the ETF. Investors can buy an ETF that tracks the Dow Jones Industrial Average ($INDU), Nasdaq health and biotechnology stocks, or the Taiwan stock market. Using an ETF, an investor can buy the small-cap value stocks of the Russell 2000 Index ($RUT.X) or overweight the health-care sector with one trade. Related news and commentary on MSN Money Because ETFs trade like stocks and investors pay just one brokerage commission on a buy or sell, its cheaper to build an overweight or underweight position with an ETF than buying a basket of individual stocks. And since theyre passively managed index funds, most ETFs charge very low management fees. The low-cost Vanguard 500 Index mutual fund carries an expense ratio of 18 basis points, but the iShares S&P 500 These advantages alone would make ETFs a solid alternative for investors who want to quickly realign a portfolio. But theres one more, and its a doozy: Investors can sell ETFs short, unlike traditional mutual funds, which makes it possible to use them to hedge against a declining market or sector. And again, thanks to the basket nature of ETFs, individual investors can use them to sell short an entire sector or market without buying options on individual stocks. Only as good as its index As an investing tool, an ETF is only as good as the underlying index. And quite frankly you cant tell much about an ETF from its name. The investor who wants to use the iShares Goldman Sachs Natural Resources Index Fund Not all indexes are equally liquid, either, and that can have a big influence on the volatility of the ETF and your ability to get in and out at your intended price. (Unlike mutual funds, ETFs are priced to market continuously during the market day, and investors buy and sell in real time and not at the end of the trading day.) The IShares Goldman Sachs Networking Index Fund ETFs may be a better way to trade energy Looking to overweight energy because the sector still has further to run this year? A good alternative is the Energy Select Sector SPDR The Select Sector SPDR- Materials A way to profit from interest rate fears Utility stocks are notoriously sensitive to interest rates since investors buy them for their dividend yields. So shorting the iShares Dow Jones Utilities Thanks to the high price-to-earnings ratios of many technology stocks, that sector is even more vulnerable to higher interest rates than financials and utilities are. And were in a period of seasonal weakness for the sector. The Nasdaq 100 Trust Shares Higher rates may create an opportunity Lets say the market continues to retreat in the face of fears of an interest-rate increase. If that happens, the actual rate increase -- especially if its more modest than some investors now fear -- could actually start a rally in some of the sectors now most under pressure. The conjunction of the timing of the Federal Reserves Open Market Committee meetings (the June 30 meeting is now widely expected to bring the first interest-rate increase) and seasonal weakness in technology stocks could add up to a bottom in the sector in late June or early July. In that case, investors would want to overweight the sector, reversing any shorts they have on in the spring. That kind of quick shift is, of course, exactly what ETFs are best for. These possible strategies and instruments are not for every investor. Theyre probably not even for most investors. Shorting, for example, is its own investing discipline that requires mastery of a different set of skills than most investors have practiced. In my next column, Ill take a look at strategies that require the hardest of all investing skills to master -- patience -- and some strategies for conservative income investors. New developments on past columns A safer way to play higher oil prices On April 21, Teekay Shipping
As of April 23, Im leaving my December 2004 target price at $77 a share. One way to invest for four different futures Pfizer Net income dropped by 50%. But much of that was due to a big gain recorded in the 2003 first quarter from Pfizers sale of several consumer businesses. Excluding what should be excluded and including what should be included, Wall Street figures that earnings climbed 27% to 52 cents a share for the quarter, a penny ahead of analyst projections. The shares now trade at 17.5 times projected 2004 earnings per share. Thats up from 15.6 last July, thanks to the stocks recent appreciation. In fact, the stock is no longer the raging bargain it was, but it should do well as investors seek predictability in a market worried about interest rate increases. As of April 23, Im leaving my target price at $42 for July 2004. (Full disclosure: I own shares of Pfizer.) Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Newmont Mining and Pfizer. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||
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