Shadow Stocks: The Low-Risk, High-Profit Way to Play the Leading Global Trends

By Horacio Marquez

Most investors know them as “exchange traded funds,” or ETFs. But we refer to them as “shadow stocks,” and with good reason.

We’ve labeled them as shadow stocks because they “shadow” the performance of a particular market, index, or sector. They’re baskets of stocks that – like mutual funds – enable you to buy or sell a portfolio of securities in a single purchase.

Unlike mutual funds, however, you can trade shadow stocks just as you would an individual stock: You can buy and sell them at intraday prices on U.S. stock exchanges, you can buy options on them, and you can even sell them “short.”

These relatively new, highly focused forms of mutual funds offer investors a diversified way to play economic sectors, global financial trends, market events and other so-called “special situations.”

But no matter how you label them – whether you refer to them as shadow stocks or as ETFs – one thing is certain: For individual investors, shadow stocks are the most-innovative, and most-powerful investment vehicle to hit the financial markets in at least two decades.

There are three key reasons why this is true. Shadow stocks:

• Offer a risk/reward profile that’s much better than either individual stocks or regular mutual funds can offer.
• Provide a way to make investment plays that would otherwise be out of reach.
• Give you terrific diversification and liquidity, offering significant safety.

Now that we’ve listed these important benefits, let’s look at each one in more detail.

Shadow Stocks: The Super Sector Selectors

If you want to succeed as an investor, there’s one key fact you need to understand. It’s so important, in fact, that in my research, writing and presentations I refer to it as Shadow Stock Profit Secret No. 1:

• It’s not the stock you buy, it’s the sector you play.

I’m always stunned by how few people actually are aware of this basic fact. But study after study bears this out: More than 50% of any gain an investor realizes in an individual stock is due to the sector it’s in, not the stock itself.

Indeed, because they are so well focused, shadow stocks (or ETFs), allow you to play the sector, theme, or global trend that will generate most of your gain.

What’s more, since they are a “fund,” shadow stocks offer risk diversification that individual stocks could never offer. If you identify a great global trend to play for a profit – but pick the wrong stock (it has an earnings disappointment, a liability lawsuit or gets caught up in a financial crisis) – you could actually incur major losses, despite having chosen a winning trend.

Putting Profits Back in Reach

That brings us to Shadow Stock Profit Secret No. 2:

• Shadow Stocks Put the “Out of Reach” Back Within Your Reach.

Here at Money Morning last year, we uncovered a fascinating investment opportunity – only to realize there was no direct way to profit from it.

Our global money-flow analysis pointed to Taiwan as a lucrative long-term investment opportunity. Drilling down, we uncovered a terrific profit play: Hon Hai Precision Industry Co. Ltd., a Taiwan-based company that manufactures all three of the hot new video game consoles that have been duking it out in the $10 billion worldwide video-gaming market. With those gaming systems, we’re talking, of course, about:

• Sony Corp.’s (ADR: SNE) PlayStation 3
• Microsoft Corp.’s (MSFT) X-Box360
• And Nintendo Co. Ltd.’s (OTC ADR: NTDOY) Wii

Hon Hai isn’t some little wannabe: As the maker of every global gizmo from Hewlett-Packard Co. (HPQ) PCs to the hot new Apple Inc. (AAPL) iPhone, Hon Hai has grown into a global leader so dominant that BusinessWeek magazine labeled it as an “earnings machine.” In fact, it’s now the biggest electronics manufacturer on the planet.

Sounds like a great investment, right?

Wrong.

Unfortunately, Hon Hai wasn’t registered with the U.S. Securities and Exchange Commission, meaning its shares weren’t available to U.S. retailer investors.

We didn’t give up, of course. While we couldn’t get around the SEC regulations, we did find another investment that held a big stake in Hon Hai – along with dozens of other Taiwanese companies with the same kind of potential. It was a “shadow stock” – an ETF called the iShares MSCI Taiwan Index (EWT). And Hon Hai’s Taiwanese shares were the fund’s largest holding.