The ETF Monthly Review: January 2020

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The ETF Monthly Review

The past decade was all about equities with the trend set to continue

By Phibion Makuwerere, Intellidex
15 January 2020

The new year which ushers in the decade of the 2020s begins with escalating geopolitical tensions between the US and Iran but with positive signals emanating from two of the major issues that bedevilled the latter part of the past decade, Brexit and the US-China trade wars.

The 2010s began a lot worse: it was the aftermath of the global financial crisis, marked by the failure of one of the biggest financial houses in the world at the time, Lehman Brothers, with many other banks and businesses pulled back from the abyss by government intervention. This birthed global quantitative easing, with the US Federal Reserve buying billions of dollars’ worth of treasuries to support the failing economy, a move later adopted by other central banks. The unprecedented supply of money and low interest rates, which make it cheap for businesses to borrow money, is now largely credited for what is the longest global equity rally in history, which continues into this decade. Unfortunately, SA failed to ride this wave due to its deteriorating political economy.

Major themes that influenced global markets in the past decade, the US-China trade tensions and Brexit, turned positive towards the end of 2019, ensuring that the decade goes down in history as one of the best for global equities. A “phase one” trade deal between the US and China looks set to be inked on 15 January and, based on recent interactions between the UK Prime Minister Boris Johnson and new EU Commission president Ursula von der Leyen, a phased Brexit deal is potentially on the cards, but risks remain.

Using the S&P 500 as barometer for global equities – given that it has the longest available historical data – the past six decades averaged a return of 7% annually, but the just-ended decade saw a significantly higher average of 11% a year.

Index performances

While this note usually focuses on reviewing monthly ETF performances, the turn of a new decade is an opportune time to take stock of the past decade and align it with long-term ETF investments. We assess briefly how some of the major asset classes performed in the last decade, including how they influenced ETF returns. Some of the findings are surprising. While timing the market is something of a fool’s task, the performance of certain assets had everything to do with timing. For instance, the JSE mining and resources indices rose ahead of other major JSE indices over the past five years – driven by the platinum group metals and gold – but they remain almost flat on a 10-year basis.

Specifically, the platinum miners index gained 200% in 2019 but its compounded annual growth return (CAGR) since 2010 was marginally negative, the poorest among major JSE indices.  You would have been better off parking your money in South African government bonds, which was the best-performing asset class in the last decade in South African financial markets.Frontier and emerging markets

With SA’s political economy deteriorating dramatically in the last decade, real returns on the JSE evaporated. The rand lost almost half of its value against the dollar since 2010, which contributed to SA losing its ranking as Africa’s largest economy to Nigeria midway through the decade. A clear winner in rewarding equity investors was the Nairobi Stock Exchange, which returned a CAGR of 10% over the decade. What’s more, Kenya’s equity annualised dollar returns for the 2010s decade outperformed the MSCI World index.Global indices

Among the major equities markets it doesn’t come as a surprise that the Nasdaq – the US-based tech-heavy index – was the best performer of the decade. Two major tailwinds, which are likely to be sustained in future, carried the index: accommodative monetary policies by central banks and the fourth industrial revolution. Two tech behemoths, Apple and Microsoft, became trillion-dollar companies, the first in history. At the other end, China’s Shanghai Composite index was the worst performer of the decade.

The ETF craze took hold in SA in the course of the last decade. There were fewer than 20 ETFs listed on the JSE in 2010 and there are 70 today (after Absa wound up five ETFs in December). This means that a lot of ETFs we review below are less than 10 years old, with about half less than five years old. Because of this, we review the performances of the ETFs in three sections: over 10 years, three years and one year.

10-year ETF returns

The Sygnia Itrix MSCI USA ETF produced a phenomenal 18% CAGR over the 10 years, buoyed by the weakening rand and the strong US equities rally. JSE-listed ETFs with offshore assets (such as the Sygnia USA fund) have two sources of return: asset price return and foreign exchange movements. The underlying assets of the fund are denoted in hard currency (dollars in this case), so any rand weakness adds a layer of foreign exchange return.

Two of the other top-performing funds over the 10 years are other ETFs holding offshore assets: the Sygnia Itrix MSCI World ETF and Sygnia Itrix MSCI Japan ETF. Completing the top five are the Satrix INDI 25 ETF and the Absa NewGold ETF, which invests in gold as a commodity.

The Satrix Resi fund had the poorest returns over the decade, losing an average of 0.2% annually.Three-year ETF returns

The past three years saw an unprecedent recovery in platinum group metal prices, driven by stricter emission controls in Europe and China, making commodities the best-performing category in that period. This saw the 1nvestRhodium giving investors a CAGR of about 100% over the past three years. This was followed by the two platinum group metal funds, Absa NewGold Palladium and 1nvestPlatinum, with CAGRs over three years of more than 42%.

The Satrix Resi and the Sygnia Itrix MSCI USA funds complete the list of the top five performers over the last three years. Noteworthy is that the Satrix Resi is marginally negative over 10 years. The troubled property sector had the worst-performing fund, with the CoreShares SA Property Income ETF losing 10.9% annually over three years.One-year ETF returns

The order of the top three does not change from the three-year returns above. The 1nvestRhodium ETF climbed 141% over the past year while the two palladium funds rose 48%. In fourth and fifth positions are offshore newbies, the 1nvest S&P 500 Info Tech Index Feeder and the Satrix Nasdaq 100, which rose more than 46% and 35% respectively. This underscores the importance of US and tech companies in investment portfolios. Again, the CoreShares SA Property Income ETF was the poorest performer, losing 7.2% in 2019.Against this backdrop, Intellidex’s portfolio of nine ETF picks performed considerably better than our benchmark in 2019. It grew 21% compared with the benchmark’s 14%, propelled by the rhodium fund.

Outlook

The performance of major asset classes – equities, bonds, commodities and cash – is influenced by the macroeconomic environment. Since JSE-listed ETFs have both local and offshore assets it means both local and international macro developments are important return drivers.

On 8 January the World Bank slashed its 2020 growth forecast for SA to 0.9% from 1.5%, citing policy uncertainty, the constrained fiscus, weak business confidence and electricity supply constraints. The bank also estimates SA’s 2019 GDP growth to have been only 0.4%, down from a previous estimate of 1.1%. And for 2021 and 2022 it says growth could improve to 1.4% – assuming that reforms announced by President Cyril Ramaphosa gather steam and the investment level improves.

This forecast is worrying and bodes ill for SA-facing companies. The local economy has been in comatose for several years, characterised by high unemployment with various output indicators flashing red lights. The need to implement reforms remains urgent. The South African Chamber of Commerce and Industry business confidence index’s 2019 average is the lowest since 1985 when SA was under sanctions. This bodes ill for private investment, an important driver of economic growth. What’s worse is that there are more downside risks for the economy. South African investors should watch out for a potential sovereign credit downgrade to junk by Moody’s if the February Budget statement fail to appease the credit rating agency. As such there is not much to be excited about with regards to local equities and any local exposure should be biased towards funds with inbuilt risk management tools.

Similarly, the World Bank cut its 2020 growth forecast for the global economy by 0.2 percentage points to 2.5%. While this is one of the lowest forecasts in recent years, it is far better than SA’s and augurs well for international equities exposure.

The biggest positive globally is what seems to be the imminent signing of a “phase one” trade deal between the US and China. The US economy has led the global economic recovery since the 2008 economic slump and its equities have spurred the global rally. With Europe and Japan struggling for growth and China slowing down, the trend is likely to remain intact although elevated US valuations are becoming a concern.

Another argument for global equities is that most central banks have shown willingness to continue accommodative growth policies should their economies show signs of weakness. And ballooning government debt levels imply that they could go on for longer in keeping interest rates artificially low and debt servicing costs manageable. Overall, we think international markets continue to offer better prospects than local markets.

However, geopolitical risks remain elevated, even with the US-Iran tensions easing after a scare in the past few days. Gold is interesting: it hit its highest level in more than six years as investors retreated to safe havens following the killing of Iran General Qassem Soleimani by the US, but retreated after the de-escalation. Goldman Sachs thinks the yellow metal still has room to rally, though the yellow metal has been this overbought only three times in the past two decades.

Some other mega trends likely to influence markets over the next decade include:

• Innovation: big data, artificial intelligence, robotics, cybersecurity, privacy, genomics, etc;
• Changing global demographics, specifically the ageing global population; and
• Planetary issues: climate change, food and water security, waste, renewable energy, energy storage, etc.

ETF strategy

Against such a backdrop, we think South African-facing stocks will remain under pressure, with the JSE generally marked by high volatility and low liquidity. A downside for ETFs is that they are index trackers, so they follow the market. If the economy is not doing well, markets fall which then translates into lower ETF returns. This underscores the need for a well-diversified portfolio.

Each month, Intellidex scans the markets to produce a list of its favourite ETFs. We classify all ETFs into six broad categories:

• Domestic equity
• International equity
• Bonds and cash
• Multi-asset
• Dividend-focused
• Commodities

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 widely recognised asset classes – equities, bonds, commodities and cash. We further split equities into geographic groupings, then add a category for equity ETFs with an income theme.

Our picks in each category should provide an investor with a relatively diversified portfolio made up entirely of ETFs. However, asset allocation is not a one-size-fits-all concept: you want to choose asset classes that 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 costs may no longer be a big issue in developed markets where they have declined significantly and do not differ much across diverse products, they are still an issue in SA. Our picks are biased towards ETFs with low total expense ratios (TERs). An overview of our favourite funds for each category follows. 

Domestic equity: CoreShares Scientific Beta Multifactor Index ETF

With the local economy facing numerous challenges, robust risk management should be employed in portfolios. While we feel the Satrix SA Quality ETF implicitly achieves this through its multidimensional approach to the selection of its constituents, our choice is a more encompassing multifactor ETF that explicitly takes volatility (including quality) into account as one of six factors it employs in fund construction. The CoreShares Scientific Beta Multifactor Index ETF fits our mould of a good investment philosophy as it is built with risk factors in mind. It was launched in May and has a great back-tested track record. The fund was up 1.9% in December but does not have a full-year record.

There are extensions to this core local equity exposure that can be added in a tactical sense as a satellite fund. We like the NewFunds Equity Momentum fund (up 4.0% in December and 23.9% for the full year).

Foreign Equities ETFs: Satrix MSCI World ETF & Satrix MSCI Emerging ETF

Foreign equities developed markets: Satrix MSCI World ETF

We maintain our foreign exposure to the broad-based Satrix MSCI World Equity Feeder ETF, which is dominated by US equities. We think US stocks are more resilient than other developed market equities during turbulence, given the relatively stronger US economy. We are, however, cognisant of the elevated US valuations relative to other developed markets. The Satrix MSCI World Equity Feeder ETF lost 1.9% in December due to the strengthening rand but is up 24.5% in 2019.

A good alternative is the Ashburton Global 1200 Equity ETF (down 1.1% December but up 21.6% over the full year). This has a bit of emerging markets exposure but comes with a higher total expense ratio. Other more focused international equity themes include property, dividend and technology funds. These are worth considering for tactical or other investor-specific reasons.

Foreign equities, emerging markets: Satrix MSCI Emerging Markets ETF

For developing market exposure we choose the Satrix MSCI Emerging Markets ETF, which was up 2.9% in December and 13.8% for the full year. It invests in a wide range of emerging economies including some of the fastest-growing markets such as China and India. The Cloud Atlas AMI Big50 (down 4.6% in December and up 15.1% in 2019), which focuses on African equities, can be used as a satellite fund to the core Satrix MSCI Emerging Markets fund. However, the Cloud Atlas AMI Big50 ETF has been extremely volatile since its listing on the JSE.

Bond and cash funds

Fixed income securities should find their way into a well-diversified portfolio due to their risk diversification attributes. If you are investing for a short period, usually less than a year, then the NewFunds TRACI (up 0.5% in December, +7.2% in 2019) is a natural choice because it is least sensitive to adverse interest rate movements. For a longer investment horizon, protecting your investment against inflation is paramount. We maintain our choice of the Satrix ILBI ETF (+0.9% December, which has the lowest expense ratio in this category. It edged up 2.5% in 2019, which is not surprising given the historically low inflation levels. Furthermore, nominal bonds add a unique risk-return dimension that differs from inflation-linked bonds and improves overall portfolio performance. The only option for local nominal bonds is the Newfunds GOVI ETF (+1.7% in December, +9.7% in 2019).

As with equities, investors also need to diversify their bond portfolios internationally. Our choice is the 1nvest Global Bond ETF (-4.3% in December, +1.7% in 2019), which tracks investment-grade sovereign bonds mostly issued by the US, UK, Japan and selected European countries. The 1nvest Global Bond ETF has the lowest total expense ratio in this category.

Dividend or income funds

If you rely on your investment income for day-to-day expenses, you may want to allocate a portion of your portfolio to ETFs that have a high distribution ratio. Property funds tend to have the highest payout ratios. Our pick here is the Satrix Property ETF (-1.4% in December, -10.7% in 2019) which has a brilliant diversification approach. For foreign property funds we like the Sygnia Itrix Global Property ETF (-4.4% December, +15.2% for the full year). It has an aggressively low total expense ratio of 0.24% that significantly undercuts its competitors, whose charges range from 0.34% to 0.52%.

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: Mapps Protect ETF (up 2.1% in December and +6.6% in 2019) is more conservative, usually suitable for older savers. Mapps Growth ETF (+3.3% December, +7.6% in 2019) suits investors with a longer-term horizon. Notably, both funds invest in SA-listed assets, thus lack an offshore flavour.

Commodities

Adding a commodity ETF to your portfolio improves diversification because commodities march to the beat of their own drum – they are not in synch with broader markets.

1nvestRhodium ETF

Based on our medium-term outlook, rhodium and palladium show decent prospects. The new vehicle emission laws in Europe and China are driving demand for both commodities and this is expected to continue in the foreseeable future. We are slightly more inclined towards rhodium because it is scarcer, with lower extraction rates from PGM ore. The primary production of rhodium is somewhat inelastic and is expected to decline moderately over the medium term. The rhodium fund edged down by -1.6% in December but was phenomenal in 2019, climbing 140.9%.

A case for gold: 1nvestGold ETF

Traditionally, gold is the preferred addition to an investor’s portfolio because over longer periods it has shown to be the least correlated with other assets. The most important attribute of gold as part of your portfolio is its excellent diversification benefits. However, its allocation in the portfolio can be increased tactically if risks and uncertainty in the near-term outlook are high, and we think risks are high in both local and global markets. The fund was flat in December but rose 15.3% in 2019.

Based on its historical price performance relative to other asset classes, gold is viewed as a risk diversifier to a portfolio containing other asset classes such as equities, bonds, real estate and private equity. It tends to do well when uncertainty is high in the market, which is usually when the other asset classes are under pressure. Proponents of gold as an investment vehicle point to its historical safe-haven status and its scarcity as appealing factors, with no single monetary authority having the power to manipulate the supply of gold indefinitely. But its limited industrial use curbs demand while its safe haven status is increasingly under question. According to the World Gold Council, 51% of demand 2018 came from jewellery manufacturing, while 42% was bought by central banks and for investment/speculative purposes. Only 8% was bought for industrial use.

Important note: Commodity ETFs do not qualify for a tax-free savings account.