The ETF Monthly Review: January 2019

Intellidex’s favourite ETFs

Each month the investment gurus at Intellidex scan the market to come up with a list of their favourites.

Orin Tambo, CFA, explains:

We classify all ETFs into five broad categories:

• domestic equities
• international equities
• bonds and cash
• multi-asset
• dividend or income-focused

Various empirical studies show that the bulk of equity returns stem from diversification among broad asset classes rather than from individual stock picking. As such, our grouping is done with a diversified portfolio in mind, ensuring appropriate exposure to different asset classes. First, we group the ETFs according to the three widely recognised asset classes – equities, bonds and cash. We further split equities into geographic groupings

We then add a category for equity ETFs with an income theme.

Our picks should provide an investor with a relatively diversified portfolio, even if it was made up only of ETFs. However, asset allocation is not a one-size-fits-all concept. You need to make sure that 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 simple but watertight investment philosophy. They should also be tax smart, which means they should qualify to be in a tax-free savings account. To avoid overconcentration, a good ETF should cap its exposure to a single sector and/or a single counter. While ETF costs are still coming down as competition among local providers intensifies, we look at this metric closely and prefer ETFs with low total expense ratios (TERs).

An overview of our favourite funds for each category follows

The January favourites:

Domestic equity: Satrix SA Quality ETF

Local equities have been disappointing for quite some time now. The JSE all share index gained a measly 13% in the five years to end-December 2018.

Unfortunately, this trend is likely to continue this year. SA’s economy is expected to remain sluggish while weak data out of Asia and Europe at the start of the year also suggest a global economic slowdown.

While there are many ways to survive depressed markets, investing in funds with quality defensive stocks could reduce losses in declining markets, while generating decent returns when the markets rise. In line with that view, we change our pick in this category from the Ashburton Equally Weighted Top 40 fund to the Satrix SA Quality ETF.

The Satrix SA Quality ETF selects constituent companies using a set of quality metrics, including return on equity, liquidity and leverage. The top 20% of all JSE-listed companies with the highest scores based on those criteria are included in the fund and weighted by market capitalisation, but capped at 10% of the fund. Empirical evidence shows that portfolios sorted on factors such as profitability and earnings quality generate high risk-adjusted returns relative to a market portfolio. However, the size of the premium varies, depending on the metrics used to calculate the quality score.

Foreign equities developed markets: Satrix MSCI World ETF

In this category we like the Satrix MSCI World Equity Feeder ETF (up 5.54% in 2018) and the Ashburton Global 1200 Equity ETF (up 4.37%). They diversify their exposure across the US, Europe, Japan, Canada and Australia. With more than half of the funds invested in US stocks, investors will still have substantial exposure to the US. Satrix MSCI World beats Ashburton Global 1200 Equity ETF on costs.

Other more focused international equity themes include property funds and technology funds. These are worth considering for tactical or other investor-specific reasons.

Foreign equities, developing markets: Satrix MSCI Emerging Markets ETF

The choice in this segment is limited to two funds: Satrix MSCI Emerging Markets and the Cloud Atlas AMI Big50. The latter was the best performer in 2018 with a return of 10.18%. Nonetheless, we still prefer the Satrix MSCI Emerging Markets ETF (down marginally by 0.51%) because of its diversification. Unlike the Cloud Atlas fund which invests in African stocks only, the Satrix fund invests in a wider range of emerging economies, including some of the fastest-growing markets such as China and India. In addition, the fund is the cheapest within its category, boasting a TER of 0.4%.

Bond and cash funds

Bonds and cash were star performers in 2018. This is because of their low risk attributes: investors tend to gravitate to lower-risk asset classes in choppy markets.  We think bonds will remain investors favourites in 2019 given the rising uncertainty in equity markets. However, expected interest rate hikes may dent the performance of some bonds.

If you are investing for a very short period, usually less than a year, then the NewFunds TRACI 3 Month (up 6.92% during 2018) is a natural choice because it is least sensitive to sudden adverse interest rate movements. It is like earning interest on your cash at the bank with a minimal possibility of capital loss.

For a longer investment horizon, protecting your investment against inflation is paramount. We therefore maintain our choice of the Satrix ILBI ETF (up 0.19%), which has the lowest expense ratio in this category.

Furthermore, nominal bonds add a unique risk-return dimension that differs from inflation-linked bonds and improves overall portfolio performance. As with equities, investors also need to diversify their bond portfolios internationally. We think investors can choose between Stanlib Global Bond ETF or Ashburton World Government Bond ETF. They track investment-grade sovereign bonds mostly issued by the US, UK, Japan and selected European countries. However, the Stanlib Global Bond ETF has the lowest TER. Both are less than a year old.