3 sophisticated ETF plays for a market that’s stopped going straight up

Investors should consider buying three sophisticated exchange-traded funds that track emerging markets, short-duration U.S. bonds and merger arbitrage for sustained gains amid a volatile market, according to an investor who specializes in ETFs.

John Davi, founder and chief investment officer of Astoria Portfolio Advisors, included the WisdomTree Emerging Markets ETF (EMMF), the JPMorgan Ultra-Short Income ETF (JPST) and the IQ Merger Arbitrage ETF (MNA) among his “10 ETFs for 2019.”

These ETFs should help investors’ portfolios generate gains as well as hedge against the high levels of volatility that are likely to remain throughout 2019, said Davi.

“There’s an inverse correlation between liquidity and volatility. With less liquidity in the system, we should have more volatility. That’s why we like diversifying our portfolio,” he added.

Last year marked the end of a market environment in which volatility was low and equities rose relentlessly. The S&P 500 posted 64 moves of at least 1 percent in 2018, eight times that of the year before. Of those 64 moves, 10 came in December as investors fretted over tighter monetary policy and fear that a recession may be looming.

“In December, stocks were priced for a recession,” said Davi. “I don’t think we’re in a recession so I’m attracted to stocks, particularly in emerging markets. They have among the highest earnings growth rates and among the lowest P/E ratios globally. That’s an attractive risk-reward scenario, in my view.”

Emerging-market stocks were hit hard last year as higher rates from the Federal Reserve, an ongoing trade war between China and the U.S. and a series of other geopolitical events depressed them.

Investors should also look at short-duration U.S. bonds as a good source of income given how flat the so-called yield curve has gotten. The spread, or difference, between the U.S. 2-year note and its 10-year counterpart is around 17 basis points, down from more than 90 basis points a year ago. The JPST fund gives investors exposure to short-term bonds.

That spread has gotten tighter as the Fed continues to raise rates and pare down its massive balance sheet. But given the worries of slowing economic growth, investors have been buying into the longer-term securities.

“With the yield curve flat, I think per unit of risk, short-duration bond funds like JPST make sense. You’re not being compensated to go up the curve,” says Davi.

Davi also said investors can get upside exposure to the market with “significantly less volatility” by buying the MNA ETF. The fund uses a merger arbitrage strategy that is long takeover targets and short global stock indexes. Merger arbitrage is a strategy often used by hedge funds that involves buying and selling stocks of two merging companies.

“Intuitively, it makes a lot of sense,” said Davi. “It’s a way to extract risk premia in the market without taking a complete market directional bet. There’s a hedging component to it.”

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