Intellidex ETF Picks
Diversification is still high on the priority list with the investment gurus at Intellidex, and this week’s ETF picks are no different which includes some newly listed global ETFs.
The uncertainty over the duration of the current lockdown restrictions as well as the overall slow pace of economic growth makes us believe an investor should remain well diversified. With the growth in global markets supported by accelerated vaccine rollouts, investors will do well to have global asset exposure. Also, the strong rand improves the case for buying offshore assets. Historically, the bulk of the returns of offshore assets have been due to the weakening of the rand.
We discuss below some of our ETF picks this month, followed by the investment rationale for each: Absa NewFunds Volatility Defensive Equity, Sygnia Itrix MSCI Emerging Markets 50, CoreShares Total World Stock Feeder and Ashburton Inflation.
Intellidex’s favourite ETFs
As discussed above, the market has mixed indicators, especially locally as lockdown restrictions are slowly phased in. Some richer countries that have managed to accelerate their Covid-19 vaccine programs are now experiencing fewer economically limiting restrictions, while poorer countries have fallen behind the curve in the rate of vaccinations. It seems it will be a long while before global immunity can be achieved, while infection and death cases rise.
There are also ongoing fears of rising inflation both locally and globally. We thus expect the market to be volatile, which is why we turn to the NewFunds Volatility Managed Defensive Equity ETF (-1% in June) to manage this volatility risk. It has a mandate of managing fund volatility and drawdowns simultaneously. Volatility is a popular financial risk measure that shows the level of variability of returns around the mean/average return. The fund exposes an investor to a universe of 30 liquid, JSE-listed equity securities selected based on their low volatility characteristics demonstrated in their performance. It consists of equity and cash in the proportion determined by the risk management process. The target volatility control mechanism aims to increase the proportion allocated to equities during periods of low volatility while increasing the proportion allocated to cash during periods of high volatility. Specifically, where volatility rises and exceeds the target threshold of 8%, the proportion allocated to cash will be increased. Where such volatility decreases, the proportion allocated to equity will be increased.
We think this fund is most suitable for investors with a relatively short investment horizon, who don’t want volatile returns, since it constantly manages its risk profile. The main disadvantage of equities as an investment asset class is that they tend to exhibit high variability of returns, particularly in the short term, a feature that this fund actively manages. The fund has about three layers of managing risk.
With the rand strengthening since the beginning of the year, it is an opportunity to increase offshore holdings. SA’s outlook remains relatively uncertain and economic recovery slower given the painfully slow vaccine program. This newly listed, CoreShares Total World Stock Feeder ETF gives investors exposure to 49 global equity markets, including developed (89%) and emerging markets (11%). This is good for diversification as different markets will exhibit different characteristics. It also conveniently combines large, medium and small caps in one ETF, which is a first of its kind for the South African investor.
The large number of shares in the ETF results in diversification through broad coverage, lower concentration, and a sizable allocation to small caps (exposure in the fund makes up approximately 10% of the total portfolio). Small caps are known to command a premium that larger shares do not. This leads to enhanced returns and over time results in both small and mid-cap shares generally outperforming large-cap shares.
Sygnia Itrix MSCI Emerging Markets 50: This is also another newly listed ETF. It is a high-risk fund that aims to replicate the yield and performance of the MSCI Emerging Markets 50 Index. This means it closely follows the index’s country weights: China (48.6%), Taiwan (19.1%), South Korea (17.6%), Brazil (4.4%) and Russia (4.4%). Investing in emerging markets in itself provides diversification because, within this emerging market spectrum, each country will exhibit different characteristics. For example, the factors at play in the fast-growing economy of China will not be the same as those in the local economy.
Although investing in emerging markets comes with high risk, it also comes with potentially strong returns: the IMF forecasts that emerging markets will grow at 6.7% this year before moderating to 5% next year, outpacing the 6% forecast for advanced economies this year and 4.4% in 2022.
Emerging market company earnings have also been strong, driven mainly by domestic consumption. Where previously emerging market companies were highly leveraged, Covid-19 presented some opportunity for deleveraging. A lot of companies could not engage in capital expenditure during lockdowns so could redirect the capital expenditure budget to paying off debt. A healthy balance sheet adds to the attractiveness of a company.
Bonds and cash funds:
While the debate on whether inflation poses short-term risk rages locally and globally, it is good practice to allocate a portion of your portfolio to inflation-indexed assets to guard against it, plus it enhances risk-adjusted returns to a portfolio of equities and nominal bonds. We still hold the view that a pre-emptive allocation to inflation-linked bonds (ILBs) may be useful.
The Ashburton Inflation ETF (-0.6%) contains diversified government inflation-linked bonds. It aims to provide an investor with a real rate of return that is above consumer price inflation (CPI). Locally, households experienced higher CPI in May (up to 5.2% year on year from 4.4% in April). This, coupled with the fact that South African government bonds offer superior returns compared to global bonds, elevates the potential return for investors invested in this ETF.
For short-term investors with a time horizon of usually less than a year, money market investments are suitable. The NewFunds TRACI ETF (+0.3%) is appropriate in this regard.
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Dividend & Income-themed funds:
The gradual reopening of economies has seen some companies resuming dividend payments. These are useful for income-oriented investors and boost the overall return on equity investments.
We like CoreShares S&P SA Dividend Aristocrats as a dividend-paying ETF – it adds constituents based on growth in dividends paid over the long term, rather than on high dividend yields. Dividend yields, which were probably elevated last year, would not have been good indicators of solid company fundamentals as they can artificially increase when the fund (-3.9%) charges a fairly high price for this income solution though, with a TER of 0.54%.
If you’d like to invest in funds that already have an asset allocation in place, then these two ETFs are the solution. They combine equities and bonds to produce a diversified portfolio for two investor types with different risk appetites. NewFunds Mapps Protect ETF (-1.4%) is more conservative and is suitable for older savers. NewFunds Mapps Growth ETF (-2.3%) suits investors with a longer-term horizon that can take on more risk. However, both funds invest in SA-listed assets, and thus lack an offshore allocation.
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SA is the world’s largest supplier of platinum group metals. Supply constraints stem from operational difficulties at mines due to lack of investment, policy uncertainty as well as disruptions in electricity supply. We believe that in the long term, volume growth for palladium will be driven by electrification in the global automotive industry. We like the 1nvest Palladium ETF (+0.1%) as it is backed by physical palladium.
However, prices have come under pressure in the wake of the strengthening rand, which does not bode well for miners.
Important note: This ETF does not qualify for a tax-free savings account.
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Our picks should provide an investor with a relatively diversified portfolio made up only of ETFs. However, asset allocation is not a one-size-fits-all concept. You need to make sure that the weights of different asset classes in your portfolio meet your unique risk-and-return objectives. Multi-asset ETFs, which are already diversified among asset classes, are analysed as a separate category.
As a rule of thumb, we like ETFs that follow a watertight investment philosophy. They should also be tax-smart, which means they should qualify to be in a tax-free savings account.
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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
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