The ETF Monthly Review: June 2018

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 five broad categories:
• domestic equity;
• international equity;
• bonds and cash;
• multi-asset; and
• dividend-focused.

We also split international equities into developed and developing markets. Not all categories are right for all investors; you want to choose asset classes that meet your unique risk profile.

We believe a good ETF should be cheap. Cost differences, while appearing small on paper, can make a huge impact on an investor’s returns when compounded over time. We also 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. Generally, to avoid overconcentration, a good ETF should cap its exposure to a single sector and/or a single counter. Below we provide an overview of our favourite funds for each category. Generally, they are the same funds from month to month and we make changes to this list when new and better ETFs (in terms of the criteria explained above) are listed, fees change or there is some other fundamental change.

The June favourites:
Domestic equity: Satrix SA Quality ETF
Satrix SA Quality remains our choice but it has performed poorly in the past few months, declining 7% in May. However, investors should take comfort in that equities experience short-term volatility but should accumulate returns ahead of inflation and other asset classes over longer periods.

From the big batch of domestic broad-based equity funds on offer, we like this ETF because it reduces the concentration risk that has come to dominate the top 40 index because it caps the weight of each counter and sector. The fund selects constituent companies using a set of quality metrics, including

return on equity, liquidity and the leverage of the balance sheet. 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, then capped each 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: Ashburton Global 1200 ETF

Less than a year old, this fund returned 2.7% in May, buoyed by US stocks which command the lion’s share of this globally diversified fund. Europe and Japan disappointed.Most diversified global funds tend to be overweight in US equities, reflecting their dominance in global equities markets in terms of capitalisation. However, we maintain our exposure to this fund because in addition to the US, it gives exposure to other developed markets: S&P 500 (US); S&P Europe 350; S&P TOPIX 150 (Japan); S&P/TSX 60 (Canada); S&P/ASX All Australian 50; S&P Asia 50; and S&P Latin America 40.A number of international-asset funds have been added since the beginning of the year – Satrix and Stanlib

recently added six funds between them. (In the returns graph, funds without a 1-year return are new funds.)

 Foreign equities, developing markets: Satrix MSCI Emerging Markets ETF

The choice in this segment is limited to two funds: Satrix MSCI Emerging Markets (-1.98% in May) and the Cloud Atlas AMI Big50 (-1.87% in May). Our choice for Satrix MSCI Emerging Markets is motivated by its diversification. The fund provides exposure to high-growth economies such as China and India, which are not included in any of the developed market funds, thus offering further diversification. The Satrix MSCI Emerging Markets ETF tracks the MSCI Emerging Markets Investable Markets index, which captures companies across 23 countries.

 Bond and cash funds

Bonds and cash are good additions to portfolios not only because of their diversification qualities but also for their ability to enhance returns.

If you are investing for a very short period, usually less than a year, then the NewFunds TRACI 3 Month (NFTRCI) is a natural choice because it is least sensitive to sudden adverse interest rate movements. It is similar to earning interest on your cash at the bank with a minimal possibility of capital loss. Its return was 0.6% in May.

However, for a longer investment horizon, protecting your investment against inflation is paramount. We therefore maintain our choice of the Satrix ILBI ETF. Less than a year old, it promises to have the lowest expense ratio of 0.22% compared with peers. It edged up by 0.08% in May.

Furthermore, nominal bonds add a unique risk-return dimension – that differ from inflation-linked bonds – which improve overall portfolio performance. The only fund in this category is the Absa NewFunds Govi.