Your aim should be to maximise quality and minimise volatility
It’s been the worst start to a year on the markets in memory. Growth in China has slowed to a dribble, commodity prices have continued to be the whipping boys of the market, and a nascent banking crisis in Europe has smacked sentiment.
Anyone holding the common-or-garden variety ETF — such as the original market-capitalisation weighted ETFs — will have felt the pain along with everyone else.
These ETFs do well when the market, or segments of the market, do well. But when the bears come out to play, they carry you off with them.
So let’s forget for a moment about how well any offshore exposure would have served SA investors last year, and contemplate how you can minimise your risks in the current market carnage.
That’s where smart beta comes in, employing a little bit of manipulation to eke out the most you can from an unforgiving market.
How does it differ? Well, traditional market-cap weighted ETFs track the overall market on the JSE. Which is fine and dandy when that market is doing well. And, to be fair, markets will do well over time: you don’t often see a market index that starts at the bottom left-hand side of the graph and winds its way to the bottom right-hand side of that graph over an extended period.
But if you want to be clever and time the market to protect yourself at a time like this, then Smart Beta or alternative indices may provide some safety. They won’t all perform the same though, so it’s important to look at the components that make up that sort of ETF.
Compare, for example, the underlying indices in two popular dividend ETFs — the FTSE/JSE Dividend Plus Index and the S&P Dow Jones Dividend Aristocrats Index.
While the Dividend Plus Index will do well in a market that’s going up, the Dividend Aristocrats Index outperforms in more volatile markets — reflecting the difference in their strategies.
The Dividend Aristocrats looks at the stability of dividends being paid out. These dividends have to grow over a five-year period otherwise they won’t be included in the underlying index, says S&P Dow Jones’ Zack Bezuidenhout.
It also has a quality filter, which ensures consistency. This favours a consistent return-on-equity, consistent dividends and low levels of debt.
However, the Dividend Plus Index takes a different approach, including stocks on a forecast basis to see what the expectation for dividends is.
The Dividend Plus’s high-yield strategy has a value tilt, but value stocks haven’t been doing well for a while now. Of course, these stocks are likely to do better in a recovering market but, right now, quality stocks that have given consistent dividends have tended to perform better.
Stripping out more volatile shares might also provide for a smoother ride.
Take Naspers: due to its sheer size and its large local shareholder base, it is one of the largest holdings in many market-cap weighted indices. So, when Naspers is doing well, market-cap ETFs tend to do well. But the opposite also holds true.
This means that Naspers wouldn’t be included in the Global Intrinsic Value (Givi) ETFs available out there, which take account of the volatility and intrinsic value of a share.
That all being said, CoreShares’ Low Volatility ETF, the LowVolTrax, failed to shoot the lights out last year. It trundled along in line with markets and delivered a return of 6%, which was more or less in line with the shareholder-weighted index.
But CoreShares MD Gareth Stobie does point out that the volatility of this fund was up to 25% lower than the Swix — a factor which could prove critical this year.
Which brings me to last year’s winners — those ETFs that shot the lights out.
Unsurprisingly Deutsche Bank’s DBX Trackers did immensely well, as the rand took an absolute thrashing against major currencies like the euro, the dollar and the yen.
The DBX Japan tracker returned over 45%, while the DBX US ETF delivered just over 33%. You wouldn’t want to throw everything at them this year, unless you’re certain of a sovereign debt downgrade, or a few more untimely cabinet changes.
Absa’s NewWave currency ETNs also did well, unsurprisingly, while its NewGold ETF benefited from the weaker rand as well. This NewGold ETF has begun this year on a belter, as gold reclaims its safe-haven status.
Defying the naysayers, property ETFs have also outperformed — particularly the PropTrax 10, which includes a rand-hedge element through the inclusion of Rockcastle and New Europe Property Investments.
Those star performers may top the list again in 2016, of course.
But as any portfolio manager will tell you, it’s all about diversification. Oh, and there’s the usual disclaimer: past performance is no guarantee of future results.
If you want to be clever and time the market to protect yourself, then Smart Beta may provide some safety