Your aim should be to max­imise qual­ity and min­imise volatil­ity

Financial Mail - Investors Monthly - - Contents - STEPHEN GUN­NION fol­low Stephen on Twit­ter @stephen­gun­nion

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

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