Tactical Investing: Pick ETFs or Stocks?

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May 22, 2009 9:05am ETF BASIC NEWS

updownBefore sifting through the investment universe for the most appropriate tool for the job, investors should be able to answer one central question: What is my investment thesis? For long-term core positions, there’s a good chance that investors can get the exposure they seek through exchange-traded funds. However, when thinking about shorter-term tactical bets (or satellite positions), the line gets blurred. Usually, the decision boils down to which ETF is the best tool for the job. At other times, the right tool might not be an ETF at all but, rather, a stock. Regardless, the key is to match the thesis with the investment vehicle that most closely correlates with your conclusion.

For example, you might think that biotechnology stocks have been unfairly beaten down with the rest of the market but still possess very promising prospects. Furthermore, you may expect that the industry’s recent merger activity will continue, as big pharma firms look to spruce up their drying pipelines with innovative technologies amid an oncoming blitz of generic competition.

Unless you’re a biomedical chemist, however, it can be intimidating to try to size up the effectiveness and efficacy of the drugs in a given biotech’s pipeline. Further, it’s extremely difficult to come up with the present value of a potential drug’s future cash flows before it even makes it through the regulatory process. In this case, it makes a ton of sense to go the ETF route, either via  SPDR S&P Biotech (XBI) or  iShares Nasdaq Biotechnology (IBB). A small position in one of these ETFs would allow investors to participate in the industry’s potential upside while simultaneously diversifying away company-specific risks.

Let’s say, however, that your investment thesis is that discretionary consumer spending will rebound sometime in the next year. In studying stock market performance coming out of previous recessions, you might have noticed that discretionary consumer stocks tend to lead the rally. Thus, this time around you plan to position your portfolio to take advantage of this trend. Despite the grim near-term outlook for the U.S. consumer, you might be inclined to take a small position in  Consumer Discretionary Select Sector SPDR (XLY), considering that the stock market is a forward-looking discounting mechanism.

Full Story: http://news.morningstar.com/articlenet/article.aspx?id=292615

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