ETFs for an Uncertain Future

Investors looking for relief from market volatility have had to deal with huge shifts in their investing strategies, as former investment favorites morph into money losers. Although the recent rally has helped many investors recover from some of their losses, stocks are still off sharply from their 2007 levels -- both here in the U.S. and around the world.

With uncertainty still all around, investors can't be blamed for seeking safety. Sectors that are traditionally identified as safe havens in uncertain times, such as health care and consumer staples, are worth looking at. Although the returns of these sectors haven't fared as badly as the overall market during the bear market, there are clearly some significant differences between them.

Consumer staples
ETFs like the Consumer Staples Select Sector SPDR (XLP) and the Vanguard Consumer Staples ETF (VDC) hold stocks of companies within the consumer staples sector. The indexes the funds track include consumer products companies that fare well in difficult economic times, such as food and drug retailing, beverages, food products, tobacco, household products, and personal products.

The Vanguard and SPDR funds have similar low expense ratios. Furthermore, these funds hold similar portfolios of large-cap U.S. stocks, with Wal-Mart (NYSE:WMT), Procter & Gamble (NYSE:PG), and Coca-Cola (NYSE:KO) among the top holdings for both. The funds are closely matched, although a recent comparison shows the Vanguard fund with a slightly smaller loss of 1.2% so far in 2009.

Health care
Within the health-care sector, the PowerShares Dynamic Pharmaceuticals Portfolio (PJP) and the SPDR S&P Pharmaceutical ETF (XPH) both track indexes of pharmaceutical companies. The PowerShares fund focuses on top names like Merck (NYSE:MRK) and Pfizer (NYSE:PFE). The SPDR fund, however, lists smaller companies like King Pharmaceuticals (NYSE:KG) and Forest Labs (NYSE:FRX) among its top holdings. Both have posted losses so far in 2009, with the PowerShares fund off almost 10% and the SPDR down 7%.

Fund facts

Source: Morningstar. YTD = year to date.

Fund prospects and risks
The argument for these sectors is pretty straightforward. Even though consumers can cut back on some consumer goods, the products made by companies within the consumer staples sector include basic necessities that most people don't cut back on even during economic downturns. 

Similarly, the need for medical care doesn't go away when money is tight, and the industry makes products that are necessary for many consumers. Although some treatment and medications can be delayed, many are not optional. Demographics are often cited as creating a strong headwind for pharma, with baby boomers clearly at an age when they are heavy health-care consumers.

The pharmaceutical industry is one of the most profitable businesses and is distinguished by high profit margins and patent protection, which can protect a company's earnings for years. Still, as you can see from this year's poor returns, the industry faces challenges, as many of those patents are ending. Moreover, a thicket of laws and regulations impede new drugs from coming online and thereby threaten earnings.

Portfolio fit?
With all the chaos still going on throughout the world's markets, there are solid reasons for seeking safe harbors. However, the sectors highlighted are no panacea for the fears roiling the markets. The funds which track these sectors are highly concentrated, so they should be sprinkled only lightly in most portfolios. The sectors do not all perform equally well, and it would be foolish for investors to blindly plunge into these areas without comparing available options.

For more on ETFs and mutual funds, read about:

• Is it time to give up on stocks?
• These funds could make you a millionaire.
• Don't blow this great chance to invest.