State Street’s Sector Picks For 2016

December 30, 2015 Let’s move outside the States. I know you consider regions much like sectors in the frame of mind of capturing a larger swath. Where’s the sweet spot outside the U.S.?

Mazza: I think it’s emerging markets, which have been beaten up. It’s difficult to find someone who likes emerging markets. But last year, we launched the SPDR MSCI Emerging Markets Quality Mix ETF (QEMM | D-89), and it slowly raised $85 million.

That’s not necessarily a home run in terms of asset gathering, but it’s interesting in light of the fact that emerging markets are significantly out of favor. A lot of our clients have come to us and said, “Hey, I know I need to be in emerging markets as a strategic allocation. But I'm not necessarily comfortable with just the market-cap-weighted approach.”

So this fund tries to find quality emerging market companies using a rules-based, smart-beta approach. But what it’s really looking to do is find companies that are attractively priced with high-quality balance sheets and high-quality earnings. If you look at the return on equity of those particular companies in emerging markets, it’s the same as what you would have received with the S&P 500, but at a much more attractive valuation multiple.

It’s more of a quality play off the idea that, in the short term, we’ll see some choppiness in markets. So with that, I probably want to be tilted toward more quality names that have better corporate governance, that have improved balance sheets. There are a lot of head winds there that we don’t expect to necessarily go away. So if I need to be [in emerging markets], I want to be there in a bit more stable fashion. And do cheaper oil prices play into that thesis for emerging markets?

Mazza: What’s interesting at the emerging market level is that there are some countries and/or companies that are going to benefit tremendously from cheaper oil. Others are going to be hurt, because they're oil exporters. We expect to see a lot of divergence of returns, as some countries do very well, some countries do very poorly. We saw that this year. We expect it to be the case. This divergence will offer up some opportunities for active management.

But for investors who want a low-cost, passive approach, we think QEMM is particularly attractive, because it’s priced at 30 basis points and gives you access to companies with strong corporate governance and strong balance sheets that are also inexpensively priced. Any other final thoughts going into the New Year?

Mazza: Over the past few years, gains have been relatively easy. Certainly 2011 was a more difficult year. 2015 has turned out to be a more difficult year. Investors may need to ratchet down their return targets. But that doesn’t necessarily mean to go to cash, or that we’re going to be in a bear market.

There's going to be a lot of opportunities, as we were discussing earlier, at the sector-industry level in the U.S. Look for value, but don’t necessarily overpay for value just because the price-to-earnings ratio looks positive. Also, this approach that we have with quality mix could be the ticket for emerging markets.

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