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Tom Lydon on CNBC on CNBC’s “ETF Edge”: Banks, Disruption, Myths, and a Model Portfolio

This article was originally published on ETFTrends.com.

With exchange-traded funds (ETFs) garnering over $300 billion in assets in 2018 despite a volatile end to the year, it's clear that there's an appetite for the ETF as an investment vehicle that's expected to continue in 2019 and beyond. However, with over 2,000 exchange-traded products (ETPs) in the marketplace, where does an investor start?

ETF Trends Publisher Tom Lydon joined CNBC's Bob Pisani on the new "ETF Edge" show on Monday to discuss opportunities in banking ETFs, disruptive technology, niche ETFs, and a model ETF portfolio to beat the market.

Should Investors Deposit into Banking ETFs?

Citigroup kicked off earnings season with banks like Wells Fargo, Bank of America and JP Morgan Chase scheduled to report later this week for the financial sector, but market mavens are mixed on what to expect, warranting caution for investors.

Citigroup was first on the docket, reporting $1.61 in profit per share, besting Wall Street expectations, but losing 21 percent in its fixed-income trading division. However, with rates rising four times in 2018, the company was able to experience growth in its pure banking business, such as corporate lending.

"It's not as though lending and credit card business was bad," said Lydon.

However, investors looking to play the  Financial Select Sector SPDR (NYSEArca: XLF) have to be wary of the dichotomy that exists between its market cap-weighted strategy and an equal weight strategy of an ETF like the  SPDR KBW Bank ETF (KBE) .

XLF lost 13 percent in 2018 with its concentrated holdings in Berkshire Hathaway and JP Morgan Chase.

"Investors and advisors are lifting up the hood and they're smelling the beta," said Lydon. "They're finding out, in fact, what's inside that index."

On the other hand, KBE lost 19.62 percent with its more diversified holdings of banks with varying sizes. Despite its performance in comparison to XLF, in essence, it gives investors a pure banking play in the ETF space.

"If you remove all of that and look at the pure banking aspect of it and you look at KBE, these are small, mid-sized banks, well-diversified, equal weight portfolio and as interest rates continue to rise, this is the bread and butter of the banking industry," Lydon added.

As an alternative to a pure banking play, investors should consider financial technology as growth in the industry continues and more consumers look to online banking to serve their finance needs. Once such ETF to consider is the  ETFMG Prime Mobile Payments ETF (IPAY) .

Portfolios Should Be More Disruptive

Whether society wants it or not, robotics, artificial intelligence (AI), machine learning, or any other type of disruptive technology is the next wave of innovation. For investors who missed out on the serendipitous run of FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks, they can look to capitalize on disruptive tech options in 2019.

Disruptive technology is not relegated to certain sectors as it will permeate into all industries in some form or fashion. For example, augmented reality is technology comprised of digital images superimposed over the real world, and its use is primed to drive industry growth–industries like real estate and manufacturing are already putting the technology to use in a variety of ways.

"It's something you need to consider as opposed to your grandfather's technology," said Lydon.

To take advantage of this transformative movement, Lydon suggests investors look at the  ARK Innovation Fund (ARKK) . ARKK’s focus is primarily on domestic and foreign equity securities of companies that coincide with the ETF’s investment theme of disruptive innovation–a technology or strategy that disrupts the status quo and develops its own niche market. ARKK invests in both developed and emerging markets with the intent to use American Depositary Receipts (ADRs)–securities offered in the U.S., but are offered as a specified number of shares in a foreign corporation.

"It's actively managed," said Lydon. "It's got robotics, AI, DNA-genome sequencing--areas of the market where if you're looking for the future of technology stocks, it's all here."

Niche ETFs Getting Even Narrower?

As investors grow more familiar with ETFs, many are using targeted ETF strategies to gain focused exposure to specific market themes and potential opportunity sets. In fact, the New York Times published an article saying that niche ETFs are getting narrower, attracting investors to a specific corner of the market without any actual profit potential.

It speaks to the case for diversification from single-stock investing via an ETF, but is the thematic space going too far and getting too niche?

"Diversification for the average investors makes a heck of a lot of sense," said Lydon.

Lydon argues that like disruptive ETFs, investors can take advantage of investments today that could potentially be the drivers of technology tomorrow.

"What about these new themes that are going to be the future 5 and 10 years later that we can invest in now," said Lydon.

With ETFs catering to the pet care industry, medical marijuana, gaming, and other niche sectors, it gives investors a wide array of opportunities to not only capture profit potential, but to also cater to investors' interests.

"Take advantage of what Wall Street has to offer," said Lydon.

"These are certain areas where if you can do it at a diversified format, it's worth it for a small amount of your money," said Lydon.

Model Portfolio to Beat the Market

With 2019 in full swing, investors are looking to adjust their portfolios after a volatile end to 2018 saw U.S. equities finish their worst year in over a decade. As such, a portfolio with a strategic mix of ETFs can not only provide investors with the upside to capture gains in U.S. equities, but also international markets and other areas of growth in 2019.

Lydon proposed the following portfolio:

Invesco S&P 500 Equal Weight ETF (RSP)

  • RSP equally weights components, so larger mid-cap tilt at 42.9%
  • Benefits from long-term outperformance of smaller-sized S&P 500 companies

Vanguard FTSE Developed Markets ETF (VEA)

  • Captures 80% of the available foreign market-cap
  • Market-cap weighting, so puts emphasis on largest firms from developed international markets

Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE)

  • targeting the emerging markets large-caps then screens the universe based on RAFI's signature fundamental factors: sales, cash flow, and equity returns to shareholders
  • These three metrics are combined to produce a "fundamentally" weighted selection universe
  • In practice, this strategy produces material sector tilts—particularly toward energy and away from technology—with a distinct value bias

NuShares Enhanced Yield 1-5 Year U.S. Aggregate Bond ETF (NUSA)

  • The Barclays Aggregate Bond Index is more risky that 10 years ago
  • NUSA shortens duration and allocates to higher quality bonds, producing greater yield than the Barclays Agg for the same risk
  • Avoids a market-cap weighted strategy; instead allocates to higher quality with higher yield bonds

SPDR® Dow Jones® Global Real Estate ETF (RWO)

  • Global real estate – 80%ish REITs, 20%ish international developers & non-REIT property developers
  • US is 57%
  • Includes some emerging market exposure
  • Developing markets are adding to global REIT opportunities

SPDR® ​  Gold Trust (GLD)

  • Gold provides greater diversification and can help stabilize portfolios during times of volatility
  • Most of retail global demand from gold comes from emerging market countries as more citizens move into the middle class
  • M&A another indicator of demand – Example as Newmont Mining buying Canadian rival Goldcorp

With an allocation to U.S. equities, developed markets and emerging markets comprising 75 percent of the portfolio, investors gain core exposure to domestic equities as well as take advantage of opportunities overseas. In addition, value-oriented aspects of the capital markets like real estate and commodities are able to capture any upside if a resurgence in these sectors occur in 2019.

"Pure quality over growth in this type of market," said Lydon.

For more market trends, visit ETF Trends.