Matt Hougan’s ‘Top 5’ ETF Picks For 2013

January 03, 2013

What's a die-hard indexer to do in 2013 with the portion of his principal devoted to speculative picks?

I don't usually get into forecasting markets, but when CNBC asked me on to give five ETF picks for 2013, I couldn't resist.

For the most part, I am one of the most boring investors I know. My core portfolio is completely indexed, built around the concepts of massive diversification and extraordinarily low costs.

It's similar—although not identical—to the World's Cheapest ETF Portfolio, which offers exposure to global equities, bonds and commodities for a blended expense ratio of less than 10 basis points per year, or $10 for every $10,000 invested.

But like many core investors, I reserve a small portion of my portfolio—up to 10 percent—for speculation. I sometimes invest this in single stocks, and sometimes in ETFs. I often sit on cash when I have no good ideas.

But my appearance on CNBC got me thinking: Where should investors put new money to work in 2013? I came up with five ideas, and in the end, invested in one. Here they are:

1) WisdomTree Japan Hedged Equity ETF (NYSEArca: DXJ)
AUM: $1.22 Billion
Expense Ratio: 0.48 Percent

This one is easy. Shinzo Abe and the new leadership in Japan are committed to printing "unlimited quantities" of yen to drive down the currency and try to end Japan's deflationary spiral. While other Japanese administrations have promised aggressive quantitative easing in the past, the language and level of commitment associated with this push seems qualitatively different. The Wall Street Journal and others have called "short yen" the "trade of the year" among hedge funds.

A falling yen will boost Japanese exporters and should spark a run-up in risk assets, including stocks. The problem with buying a traditional Japanese equity ETF like the iShares MSCI Japan ETF (NYSEArca: EWJ) is that any increase in equity prices could be offset by the impact of a falling currency. DXJ hedges out that currency exposure, leaving you with pure exposure to domestic equity prices. It even goes one step further, using a weighting system that emphasizes exporters, who stand to benefit from the falling yen.

I'm not alone in liking DXJ: It pulled in $505 million in new assets in December alone, and has beaten the pants off of EWJ over the past month.

2) Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC)
AUM: $1.21 Billion
Expense Ratio: 0.47 Percent

Like DXJ, this one seems a bit of a no-brainer. Compared with developed-markets debt, EMLC and other emerging-market-debt ETFs give you exposure to better balance sheets, higher growth and better yields. EMLC has a 30-day SEC yield of 4.80 percent, compared with just 1.61 percent for the iShares Core Total U.S. Bond Market ETF (NYSEArca: AGG). When you combine that with the fact that most investors have zero or near-zero exposure to international debt, EMLC seems like a strong candidate.

What's holding it back? The fund has underperformed lately compared to dollar-denominated emerging market debt because the dollar has been on a tear. The debate between funds like EMLC and dollar-denominated products is legitimate. But personally, I'll take on the currency risk for the added diversification benefit.


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