3 Low-Risk ETFs to Ride Out a Volatile Spring

Includes: IYH, XLP, XLU
by: Charles Lewis Sizemore, CFA
Investors got a shock in March as a series of popular uprisings in the Arab world morphed into an all-out civil war in Libya and an earthquake in Japan threatened to unleash the worst nuclear disaster since Chernobyl. Add to this the lingering European sovereign debt crisis—which just caused the Portuguese government to fall—soaring energy prices, and a housing market that appears to be in the early stages of a double dip, and it is not surprising that investors are apprehensive.

After two solid years of gains, many global stock markets are flat or down for 2011. The question on every investor’s mind at the moment is “What happens next?”

Unfortunately, this is the wrong question to be asking. No one knows what the future holds, but as prudent investors we don’t have to. As Benjamin Graham, the mentor of Warren Buffett and the father of the investment profession, eloquently wrote, “Forecasting security prices is not properly a part of security analysis.”

The economy may be slipping back into recession—or it may not. But as investors, the questions we should be asking are “At current prices, can I expect a reasonable return?” and “Is the risk I’m taking proportional to the return I hope to achieve?”

You cannot control whether the economy dips into recession or not. But you can control what price you pay for your investments. Investors with this perspective can keep their emotions in check and avoid selling at the wrong times. This strategy will not always beat the market, but it will help investors minimize costly mistakes that they will regret later. It also allows investors to successfully take the other sides of trades when others are panicking.

With this in mind, what investments look attractive in this environment?


Let’s start by taking a look at a sector that took a beating during the Japan nuclear crisis: utilities. Few sectors got hit as hard as the normally-boring utilities sector. The Utilities Select Sector SPDR (NYSE: XLU) —generally one of the most conservative sector ETFs—fell by 7% in a matter of days on investor fears that Japan’s nuclear crisis would result in America’s nuclear power providers coming under greater regulatory scrutiny. But does this make sense? Most American utilities have little exposure to nuclear energy, and it is difficult to argue that those that do are somehow more at risk due to an earthquake half a world away.

At a time of high energy prices, what politician would want to do anything that would further crimp supply and cause prices to go even higher? Utilities would seem like an attractive investment at current prices. The sector trades at a P/E of 12 and pays a solid, safe, and growing dividend yield of 4%. Should the bull market resume, the utilities sector should participate in the rally. But if we drift back into recession, investors can still enjoy a yield that is higher than what they can get in much of the bond market while waiting for prices to recover. XLU is a buy.


The global telecom industry also looks attractive at current prices. Fixed-line telephony might be in slow decline in America and Europe, but the mobile market still has years of growth due to subscribers upgrading to smart phones with data plans. And in many emerging markets in which American and European firms operate, both fixed-line and mobile telephony are still in the growth phase. Consider picking up shares of the iShares S&P Global Telecommunications ETF (NYSE: IXP).

IXP is a collection of global telecom heavyweights like AT&T (NYSE:T), Verizon (NYSE:VZ), Vodafone (NASDAQ:VOD) and Telefónica (NYSE:TEF). Like XLU, this ETF trades at a rock-bottom 12 times earnings and yields a healthy 4% in dividends—again, more than you can expect to get from a 10-year Treasury note. Whichever way the economy goes, IXP would seem like a reasonable place to park a portion of your investment capital.

Health Care

Finally, investors should take a long, hard look at the Big Pharma sector. Investors currently have no love for the large-cap health care sector. Health care was the worst-performing sector in 2010 and after financials, the worst-performing sector of the past five years. Not surprisingly, it is also one of the least-recommended sectors by Wall Street strategists as reported by Barron’s. Bearishness towards this sector stems from patent expirations, lingering fears over ObamaCare, and investor disenchantment with the performance of the sector in recent years. The result is that Big Pharma has essentially been left for dead. The iShares Dow Jones US Healthcare (NYSE: IYH) trades at a P/E of only 13—a level that more than compensates investors for the risks facing the sector.

At current prices it is difficult to see IYH having much in the way of downside, recession or not. Without a crystal ball, we have no way of knowing what tomorrow might bring. Certainly, the Japanese victims of the earthquake and tsunami had no way to know that their lives were about to be turned upside down. But by buying your investments right, you give yourself that all-important margin of safety, and you don’t have to know what the future holds.

This article originally appeared on InvestorPlace

Disclosure: I am long XLU, IYH, IXP.