Intellidex ETF Picks
Diversification is key in this weeks Intellidex Exchange Traded Fund (ETF) picks which offers a broad range of ETFs INVSTRs should take note of in the early phase of the upward cycle.
Macroeconomics
We are cautiously optimistic against the current backdrop and expect the following themes within global markets over the short to medium term:
- A global economic recovery boosted by vaccines and fiscal and monetary stimulus.
- Equity markets to outperform bonds due to low interest rates, economic growth and recovering earnings.
- Non-technology developed market equities to benefit from the rotation into “value” stocks (explained below).
- Emerging markets (including SA) to continue benefiting from improved sentiment and demand for commodities.
- A weakening dollar as capital flows to emerging markets.
- Growth in demand for environmental, social and governance (ESG) investments.
Intellidex ETF strategy
We continue to favor broad exposure in different regions using the ETFs below as this may offer investors the best exposure to what can be described as the early phase of an upward cycle. The ETFs are: Satrix Top 40; NewFunds Value Equity or Ashburton MidCap; MSCI World ESG Enhanced; MSCI EM ESG Enhanced; and Sygnia Itrix MSCI Japan. We list other ETFs as tactical investments for more opportunistic investors.
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Now for the Intellidex favorite ETF picks
Local (Domestic equity):
As the improved sentiment towards SA equities due to the global economic recovery continues, investors are likely to opt for the larger, liquid companies listed on the JSE. Consequently, we retain our core holding in the Satrix Top 40 ETF (+5.3% in January), which provides broad exposure to the SA market. It also offers indirect exposure to companies that generate some of their revenue offshore, which provides a diversification benefit. The fund has the lowest total expense ratio (TER) among its peers at 0.12%. From a tactical perspective, we believe that value stocks may continue to outperform momentum, growth and quality stocks as was the case towards the end of 2020.
Importantly, data from leading index provider MSCI show that value was relatively cheaper than its counterparts using fundamental data such as the forward dividend yield and forward price: earnings ratio to end-December 2020. The NewFunds Value Equity ETF (+2.0%) provides exposure to value stocks, particularly as the economic recovery will benefit non-technology sectors such as financials, utilities, and consumer-facing sectors. The Ashburton MidCap (+1.2%) and Satrix FINI (-3.2%) ETFs may also be useful for higher-risk investors looking to gain exposure to relatively cheap, domestically focused companies.
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International (Developed Markets):
President Joe Biden has initiated the process of the US re-joining the Paris Climate Agreement, which signals the new administration’s focus on environmental issues. Consequently, we expect ESG investments to gain more prominence globally as the US resumes its important role in environmental policy. The Satrix MSCI World ESG Enhanced ETF (+4.0%) provides both broad exposure to global equities and exposure to companies that are favorably ranked with respect to ESG factors.
Separately, we still maintain Sygnia’s MSCI Japan ETF (+1.7%) as a tactical investment. Japan’s export-oriented economy could benefit as the global economy recovers. Global investment firm Schroders expects economic growth of 2.9% for Japan in 2021 and the fund is invested in the relatively underpriced non-technology sectors such as industrials and consumer discretionary, which make up 39% of the fund.
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Emerging Markets:
The Satrix MSCI EM ESG Enhanced ETF (+4.4%) is similar to its global counterpart. In addition, emerging markets as a distinct asset class provide the global investor with exposure to the world’s fastest-growing economies in the synchronized recovery. The fund’s allocation to Chinese equities may lead to a high concentration, which reduces diversification. However, it still provides exposure to the country that leads the global economic recovery.
The inclusion of the superpowers’ companies in the ETF will also be of interest given the interventionist nature of the Chinese government, criticism of the way it handled the Covid-19 outbreak and its tense trade relations with Australia.
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Dividend & Income-themed funds:
For investors who rely on investment income to fund day-to-day expenses, an allocation of a portion of their portfolio to ETFs that pay high dividends may be useful. We maintain our choice of dividend-focused strategies: CoreShares S&P Global Dividend Aristocrats ETF (+2.3%) and the CoreShares South Africa Dividend Aristocrats ETF (+1.1%).
A key advantage of the dividend aristocrat strategy is that it selects constituents based on growth in the absolute size of dividends rather than the dividend yield. This is particularly important now when financially challenged companies may exhibit deceptively high yields because of low share prices, such as property funds. The strategy also tends to select companies that can endure difficult market and economic environments and whose earnings are not cyclical. This makes the fund overweight in highly cash-generative and resilient sectors. The main drawback is that these funds are pricey. The CoreShares S&P Global Dividend Aristocrats has a TER of 0.59% and the CoreShares South Africa Dividend Aristocrats ETF costs 0.87%.
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Bonds and Cash funds:
Bonds improve risk-adjusted returns of the overall portfolio as they are uncorrelated with equities and this improves portfolio diversification. Also, SA bond yields remain higher than global bond yields, which could drive global investment into our local bonds if a “risk-on” environment persists. We also think that bonds can benefit if the SA government implements expenditure cuts and reforms needed to address structural weaknesses in the economy.
Consequently, investors can gain exposure to local bonds through the Satrix SA Bonds ETF (+0.6%), the cheapest in its class. This fund pays a quarterly dividend which can provide relief to an investor in the current environment of declining disposable income.
For short-term investors, usually less than a year, the NewFunds TRACI (+0.3%) is the appropriate investment vehicle.
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Diversified funds:
If you find the process of diversifying your portfolio daunting, two ETFs will do it for you. They combine equities and bonds to produce a diversified portfolio for two investor archetypes with differing risk appetites:
NewFunds Mapps Protect ETF (+2.6%) is more conservative, usually suitable for older savers.
NewFunds Mapps Growth ETF (+3.7%) suits investors with a longer-term horizon. Notably, both funds invest in SA-listed assets, thus lacking an offshore allocation.
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Commodity funds:
Adding a commodity ETF to your portfolio improves diversification because commodities march to the beat of their own drum – they are not in sync with broader markets. Rhodium has been our metal of choice and has boosted our portfolio performance.
In addition, the structural drivers for rhodium remain strong through demand for greener and cleaner technology in the automotive industry. However, rhodium remains in short supply due to capacity constraints in SA, where 85% of global rhodium is sourced and mines face operational difficulties from a lack of investment, policy uncertainty and unstable electricity supply. As a result, we think that the rhodium price will enjoy continued support until supply increases.
The 1nvest Rhodium ETF (+23.5%) is our preferred vehicle for investors seeking exposure to rhodium as it presents the strongest fundamentals out of all the PGMs. This ETF is backed by physical rhodium. The drawback is that the EFT is quite pricey, with a TER of 0.75%.
Important note: This ETF does not qualify for a tax-free savings account.
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Final thoughts
We believe investors should remain invested in well-diversified portfolios over meaningful time horizons to help mitigate risk. In addition, we still prefer a healthy portion of investment in global assets due to weak conditions locally. The performance of these investments will enjoy a boost from any rand depreciation.
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Background: Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) are passively managed investment funds that track the performance of a basket of pre-determined assets. They are traded the same way as shares and the main difference is that whereas one share gives exposure to one company, an ETF gives exposure to numerous companies in a single transaction. ETFs can be traded through your broker in the same way as shares, say, on the EasyEquities platform. In addition, they qualify for the tax-free savings account, where both capital and income gains accumulate tax free.
Benefits of ETFs
- Gain instant exposure to various underlying shares or bonds in one transaction
- They diversify risk because a single ETF holds various shares
- They are cost-effective
- They are liquid – it is usually easy to find a buyer or seller and they trade just like shares
- High transparency through daily published index constituents
Disclaimer
This research report was issued by Intellidex (Pty) Ltd. Intellidex aims to deliver impartial and objective assessments of securities, companies or other subjects. This document is issued for information purposes only and is not an offer to purchase or sell investments or related financial instruments. Individuals should undertake their own analysis and/or seek professional advice based on their specific needs before purchasing or selling investments. The information contained in this report is based on sources that Intellidex believes to be reliable, but Intellidex makes no representations or warranties regarding the completeness, accuracy or reliability of any information, facts, estimates, forecasts or opinions contained in this document. The information, opinions, estimates, assumptions, target prices and forecasts could change at any time without prior notice. Intellidex is under no obligation to inform any recipient of this document of any such changes. Intellidex, its directors, officers, staff, agents or associates shall have no liability for any loss or damage of any nature arising from the use of this document.
Remuneration
The opinions or recommendations contained in this report represent the true views of the analyst(s) responsible for preparing the report. The analyst’s remuneration is not affected by the opinions or recommendations contained in this report, although his/her remuneration may be affected by the overall quality of their research, feedback from clients and the financial performance of Intellidex (Pty) Ltd.
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Intellidex may also have, or be seeking to have, a consulting or other professional relationship with the companies mentioned in this report.