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ETF Strategies to Smooth Out a Bumpy Road

This article was originally published on ETFTrends.com.

As ETF investors carefully look over the current market environment, many are considering equity and fixed-income strategies that could help diversify and enhance an investment portfolio in a more trying environment.

On the recent webcast, Macro Strategies: Navigating Choppy Market Waters, Kevin Flanagan, Senior Fixed Income Strategist for WisdomTree, argued that supportive elements that previously bolstered the economy and U.S. markets are beginning to fade so investors should hold back expectations. While we continue to see the economy improve, with strong GDP, stable inflation and robust employment with rising wages, the economy is moving toward the later stages of the traditional business cycle and investors should take steps to adapt to the changes.

While there may be growing risks, Jeremy Schwartz, Executive Vice President and Global Head of Research at WisdomTree, believed that investors should not lose sight of the equities market. Global stocks took a heavy blow in the past year, but they have also staged an impressive rebound in the first month of the year. Many investors are stepping back in to get in on a cheap entry point, with the S&P 500 showing an estimated price-to-earnings of 16.5x, compared to its average of 18.0x

Some investors, though, remain cautious of the rebound, but Schwartz pointed out that there are also more defensive ETF strategies that may hold up better in these trying times. Specifically, he highlighted factor investments.

"The quality factor has outperformed in late stages of market cycles and during market slowdowns," Schwartz said.

"Quality stocks are well positioned for higher volatility, but active funds are underweight high quality stocks," he added.

ETF investors can look to a fund like the WisdomTree U.S. Quality Dividend Growth Fund (DGRW) as a way to hone in on quality names and and still generate some extra cash on the side. DGRW includes companies with high long-term earnings-growth forecasts for the next three to five years and weights components based on the value of dividends they are expected to pay over the next year. The ETF is not heavily weighted to the rate-sensitive sectors that are often prominent in many yield-based dividend funds.

Furthermore, Schwartz underscored the opportunity in emerging markets as the EM valuation gap compared to the S&P 500 is flashing a value signal. The MSCI Emerging Markets Index was trading at a 32% discount to the S&P 500, or near levels not seen since 2003. This is significant since during 2003 through 2007, the MSCI Emerging Markets Index returned a cumulative 383%, compared to the S&P 500's 83% return. When the valuation gap widened to this degree in previous periods, the emerging markets have historically outperformed the S&P 500 90% of the time over the following five years by an average of 14.5% annualized.

Something like the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE) can help investors tap into emerging opportunities and avoid exposure to companies that are controlled by the state, which is defined as government ownership of more than 20%.

On the fixed-income side, investors who are wary of further rate hikes have a number options to hedge against further risks and still maintain income generation. For example, the WisdomTree Bloomberg Floating Rate Treasury Fund (USFR) , which follows the Bloomberg U.S. Treasury Floating Rate Bond Index, focuses on floating rate notes. Instead of paying a fixed rate of interest like other Treasuries, floating rate note coupon payments are based on a reference rate (90-day t-bills) plus a spread. Since 90-day bills are auctioned every week, the effective duration of floating rate notes is one week, which allows investors to capture higher rates of income as short-term rates rise. This also provides an opportunity for investors to boost income as the Federal Reserve hikes interest rates.

"Even without a rate hike, the flat/inverted yield curve offers yield without the duration risk," Flanagan said.

For those seeking more yields but would also like a defensive tilt, investors can also look to a quality high-yield bond ETF strategy. The WisdomTree Fundamental US Short-Term High Yield Corporate Bond (SFHY) tracks the WisdomTree Fundamental U.S. Short-term High Yield Corporate Bond Index. The index is designed to capture the performance of selected issuers in the short-term U.S. non-investment-grade corporate bond market that are deemed to have favorable fundamental and income characteristics.

Financial advisors who are interested in learning more about investment strategies for the environment ahead can watch the webcast here on demand.