The ETF Monthly Review: September 2019

Ernest Nkomotje
By Ernest Nkomotje September 11, 2019 11:47

The ETF Monthly Review: September 2019

The ETF Monthly Review

Welcome to this month’s ETF Review, a neat update of market news affecting ETFs, as well as a set of favourite funds chosen by the Intellidex team. We collaborate with Intellidex to bring you the latest insights on ETFs – probably the niftiest way to invest!


What happened in the markets in August?

  • Global bonds, rhodium and a weaker rand boost JSE-listed ETFs in August
  • Deteriorating local political economy raises downside risks for local equities
  • Trade wars and Brexit remain the biggest global risks to growth and markets

Our favourite ETFs

  • Domestic equities: CoreShares Scientific Beta Multifactor Index ETF (new selection!)
  • Foreign equities: Satrix MSCI World ETF and Satrix MSCI Emerging Markets
  • Bonds and cash: NewFunds TRACI 3 Month (short term); Satrix ILBI ETF, Stanlib Global Bond ETF (long term)
  • Dividend/income funds: Stanlib SA Property ETF and Sygnia Itrix Global Property ETF
  • Commodities: Standard Bank Africa Rhodium ETF

What’s happened in the markets?

August saw broad-based global equity declines amid toned-down dovish comments from the US Federal Reserve, trade war uncertainty and the possibility of a hard Brexit. Locally, the political economy remains poor and the all share index, in sympathy with global equity indices, closed lower.

Assets considered safe havens such as gold and developed market bonds surged, with yields on some bonds turning negative or moving deeper into negative territory. The rand was caught in the crossfire and depreciated by 5.5% against the dollar. US Treasuries suffered inverted yields on two- and 10-year bonds, where the short-term yield is higher than the long-term yield. Historically, such an occurrence has preceded a recession. Against this backdrop the equally weighted portfolio of all JSE-listed ETFs returned 2.16% in August, helped by funds containing international assets as foreign exchange gains accounted for the bulk of the return. A particularly strong performance was recorded in international bonds because bond prices rise when yields fall.

Intellidex’s ETF portfolio rose 2.11%, buttressed by its exposure to rhodium. However, separating JSE ETFs in local, international and commodity assets is revealing. The average return on JSE-listed international asset ETFs was 5.17% while local asset ETFs declined by an average of 2.38%. Commodity ETFs outperformed all JSE ETF classes, climbing by an average of 17.2%.


Intellidex’s favourite ETFs

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

Phibion Makuwerere, CFA, explains:

We classify all ETFs into six broad categories:

  • domestic equities
  • international equities
  • bonds and cash
  • dividend or income-focused
  • multi-asset
  • 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 the three widely recognised asset classes – equities, bonds and cash. We further split equities into geographic groupings, 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 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 competition among providers is intensifying and ETF costs are coming down, 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 August favourites:

Domestic equity: CoreShares Scientific Beta Multifactor Index ETF

The local political economy presents numerous challenges and robust risk management practices should be employed in portfolios. While we feel the Satrix SA Quality fund implicitly achieves this through its multifactor fund construction approach, there is a new (rebranded) multifactor ETF which explicitly takes volatility 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 to achieve superior risk-adjusted returns to

Local markets: June performance

The all share index fell 2.7% in August, weighed down by industrials and financials which declined 4.4% and 3.8% respectively. However, the mining index held steady, edging up 0.8%, while its sub-indices of gold and platinum climbed 29% and 12.9%, helped by a spate of good company results and a solid performance in the underlying commodity prices. Gold climbed 14.6%.

In the PGM group metals, the dollar price performance was markedly varied: the star performer, rhodium, climbed 24.7% while platinum and palladium rose 6.6% and 0.4%. Outside of commodity ETFs, the nominal government bond (NewFunds GOVI) ETF was the best performer, rising 1.1%, followed by the money market fund which edged up 0.6%. Property funds were the biggest losers. The Satrix Property and CoreShares Property Top Ten ETFs lost 5.7% and 5.1% respectively. Given the strong performance in the rhodium dollar price coupled with the rand’s depreciation against the greenback, the Standard Bank Africa Rhodium ETF soared 48.8%, by far the most rewarding fund for investors. This ETF has now returned 117% since the beginning of the year. Bar palladium funds, all the other commodity funds managed double digits returns of between 14.5% and 15.1%.

the traditional top 40 index. It was launched in May and has a great back-tested track record. On a cumulative basis it would have outperformed the top 40 index by 79% over the past three years to end-June. We thus change our main choice for local broad-based equity exposure to this new multifactor fund. The fund fell by 2% in August but still outperformed the Satrix SA Quality ETF which shed 2.9%.

There are extensions to this core local equity exposure that can be added for tactical reasons as a satellite fund. The NewFunds Equity Momentum fund (up 0.4% in August) is worth considering. It has performed far ahead of other equity funds under all market extremes in the past four months and has a year-to-date return of 17.8%. The Satrix Indi is in second position but is far behind with a year-to-date return of 8.0%. However, the sample period is too short to draw strong conclusions

Developed markets Foreign equities: Satrix MSCI World ETF

We maintain our 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.

International markets: June performance

The biggest loser of the month was the UK’s FTSE100, which tanked 5.0% as fears of a hard Brexit gathered pace. The US S&P500 decreased 1.8% while Germany and Japan’s main indices declined 1.9% and 3.8% respectively. The three top performers were bond ETFs, with returns concentrated between 10.7% and 11%. Among international asset ETFs, the Cloud Atlas Africa Real Estate ETF was the only fund to record negative growth, shedding 5.5%.

Macro review and outlook

Locally, the political economy leaves much to be desired. Investors feel government is moving too much to the left, pushing populist policies including NHI and debt relief which are economically damaging. Adding confusion to the already precarious situation is finance minister Tito Mboweni’s economic policy paper which differs, on several important issues, from that of the ANC and its alliance partners. Topping it off is the ballooning debt of Eskom which recently reported a loss of R21bn in its year to end-March.

Although latest readings of the SACCI business confidence and Absa purchasing managers indices paint a bleak near-term outlook as they are below neutral readings, some good news came from the Q2 GDP growth rate, which increased 3.1% over the previous quarter. However, this strong growth was off a low base in the first quarter, when the economy contracted. We forecast GDP growth of just 0.6% this year.

Against this backdrop we think South African-facing stocks will remain under pressure, with the JSE generally marked by high volatility and low liquidity. However, the local bourse is likely to benefit from heavyweights, including miners, which are exposed to international markets.

Significant risks to the global economy will prevail, we think, until the US-China trade wars and Brexit are resolved. While the US economy remains relatively strong and to some extent Japan, we are seeing worrying weaknesses in Germany and China. Some commentators believe these weaknesses show that the trade war is beginning to take effect. Towards the end of July, the IMF reduced its global growth forecast for this year by 0.1 percentage points to 3.2%, citing low investment and supply chain disruptions due to Brexit and the trade war. The demand for safe haven assets such as gold and bonds has risen. In August an influx of capital into longer-dated bonds saw the yield curve of the US 10-year government bond falling below the two-year bond yield, forming an inverted yield curve. The last time this happened was 2007, just prior to the global financial crisis. An inverted yield curve shows that investors are wary of near-term prospects and they hedge their positions by parking funds in longer-term bonds.

Highlighting the confusing state of affairs are contrary views by two global financial powerhouses, JPMorgan Chase and UBS Wealth Management. While JPMorgan issued a buy call generally on equities, UBS is advising clients to reduce their equity holdings. JPMorgan believes that accommodative monetary policies will save the day, but more recently both the US Federal Reserve and the European Central Bank have toned down their dovish stances.

Brexit and the trade war present strong and unpredictable risks. It’s difficult to anticipate how the trade war will end due to the erratic nature of US president Donald Trump, but there is a meeting planned for next month in Washington. Similarly, amid all the twists and turns when it comes to the Brexit, recent developments show that the majority of the British parliament is not ready to leave the EU without a deal. Still, business in the UK, and to some extent in the EU, will remain under pressure due to low investment levels until there is some certainty.

Bottom line

The short-term outlook is clouded by high uncertainty both at home and internationally and volatility is likely to be elevated. To sleep better at nights, investors should build balanced portfolios incorporating various asset classes to help withstand or limit the adverse impact of elevated market volatility. ETFs can help to achieve this.

The Satrix MSCI World Equity Feeder ETF grew 4.3% in August.  A good alternative, though, is the Ashburton Global 1200 Equity ETF (up 3.3%) but it has 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.

Developing markets foreign equities: Satrix MSCI Emerging Markets ETF

We choose the Satrix MSCI Emerging Markets ETF (+1.5%) as our core portfolio for developing market exposure. 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 (+8.8%), which focuses on African equities, can be used as a satellite fund to the core Satrix MSCI Emerging Markets fund.

Diversified funds

If you find the process of diversifying your portfolio daunting, two ETFs can 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 (1.5%) -is more conservative, usually suitable for older savers. Mapps Growth ETF (-2.8%) suits investors with a longer-term horizon.

Dividend or income-theme 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 pay-out ratios. We maintain our choice of the Stanlib SA Property ETF
(-4.3%), which boasts the lowest TER in the segment. For foreign property funds, the Sygnia Itrix Global Property ETF +7.8%) is the cheapest in this category.

Bond and cash funds

Bonds 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 3 Month (0.6%) is a natural choice because it is least sensitive to adverse interest rate movements. You can also park your funds in a money market fund if you’ve a lump sum that you wish to put down as a deposit for big-ticket items like a house or car while you shop around. You’ll generally earn better returns than the interest in a bank account.

For a longer investment horizon, protecting your investment against inflation is paramount. We maintain our choice of the Satrix ILBI ETF (-0.9%), 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. The only option for local nominal bonds is the Newfunds GOVI ETF (+1.1%). As with equities, investors also need to diversify their bond portfolios internationally.

Our choice is the Stanlib Global Bond ETF (+11.0%) which tracks investment-grade sovereign bonds mostly issued by the US, UK, Japan and selected European countries. The Stanlib Global Bond ETF has the lowest TER in this category.

Commodities: Standard Bank Africa Rhodium ETF

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. 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. However, our preference based on our medium-term outlook is between rhodium and palladium.

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 Standard Bank Africa Rhodium fund climbed a phenomenal 48.8% in August.

Ernest Nkomotje
By Ernest Nkomotje September 11, 2019 11:47

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