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.