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Many self-directed investors have two inter-related problems: insufficient allocation to global equities and thus limited exposure to investment megatrends.
An overweighting of Australian shares creates concentration risk in bank and resource stocks, given those sectors account for half of ASX 200. The top 10 stocks in the S&P/ASX 200 alone, mostly banks and giant resource companies, are worth 45% of the index.
Equally worrying is the low exposure this creates in technology, healthcare and other growth sectors.
Consider an investor who has a $1 million portfolio and invests a third of it in cash, a third in an investment property and a third in Australian shares (through an ASX 200 Exchange Traded Fund). Only $8,000 of their portfolio would be exposed to tech stocks (given the IT sector’s 2.3% weighting in the ASX 200). Even then, the portfolio is only exposed to Australian tech stocks, when most of the action in this sector is overseas, notwithstanding recent gains in our IT sector.
I am not proposing that investors blindly follow megatrends and overlook valuations. Or add too much exposure to tech and other sectors that have higher risks. But those with multi-year, or multi-decade, investment horizons need exposure to powerful long-term trends.
For example, how will an investor capitalise on the coming boom in middle-class consumption, with another two billion Asians expected to join the global middle class by 2030 on OECD forecasts? Leading Asian consumer staples and technology companies have good prospects.
How will they capitalise on growth in global cybersecurity spending, as companies pour trillions of dollars into technology systems to combat cybercrime? And what about the benefits from the coming boom in artificial intelligence, automation and the Internet of Things?
The case to add small exposures to select megatrends in the global-equities component of portfolios is definitely building.
Investors interested in global megatrend investing should consider Exchange Traded Funds (ETFs) on the ASX. Low-cost products only provide the market return, but if you pick the right megatrend, the return is attractive.
Here are three ETFs that suit global megatrend investing:
Investing in Australian healthcare stocks is challenging on two fronts. First, there is only a handful of large healthcare or medical-device stocks on the ASX. Second, this limited choice arguably leads to a “scarcity premium”; investors want healthcare exposure, so pay higher prices.
Most healthcare action is overseas. The iShares Global Healthcare ETF provides exposure to 104 of the world’s largest pharmaceutical, biotechnology and medical-device companies. About 70% of the ETF is invested in United States healthcare companies.
An ageing global population is a tailwind for healthcare companies and the boom in middle-class consumption in Asia will drive stronger spending on healthcare. Having more exposure to the global healthcare sector is a no-brainer for investors with a long investment horizon.
I have written about this ETF several times over the past five years. The one-year return to 31 July 2018 is almost 20%. The annualised return over five years is about 15%.
Prospective investors need to have a view on the Australian dollar as well as healthcare stocks because the ETF is unhedged for currency movements.
The ETF provides exposure to 60 of the world’s largest agriculture stocks. Like the healthcare ETF mentioned earlier, this one fills a gap for Australian investors because there are few large agricultural companies listed on the ASX.
A global approach to agriculture investing is critical: having different country and soft-commodity exposure reduces risks. The devastating effect of drought in parts of Australia on agriculture reinforces the need to invest across countries in this sector, so that portfolios are not overexposed to climatic risks in one region.
The agriculture sector has tremendous long-term prospects. Food demand will soar as the world population reaches an estimated 9.7 billion by 2050 and as a new generation of middle-class Asian consumers upgrade their diets.
An extra 70 million people each year will need to be fed. But arable land is shrinking because of population growth, urbanisation and rising desertification. Acute water shortages and higher climate volatility in coming decades are other threats.
The BetaShares ETF is a simple, low-cost way to gain exposure to rising global demand for food. The ETF has delivered an annualised 10% return since inception in August 2016, but has had a modest return over the past year (5%).
The annual management fee is 57 basis points and the ETF is hedged against currency movements.
TECH tracks the performance of the Morningstar Developed Markets Technology Moat Focus index. Unlike similar ETFs that are weighted by company capitalisation, TECH uses an equally weighted index – each stock, regardless of size, has the same index weight.
The index includes tech companies Morningstar believes have the strongest competitive advantage (moat) and are attractively priced. Most of them are large US companies.
TECH returned 35% over one year to July 2018, thanks to the rally in US tech stocks. The ETF’s underlying index has delivered consistent, strong performance over a decade. The 10-year annualised return is 18%.
The inclusion of large tech companies Morningstar believes have sustainable competitive advantages is a selling point.
By focusing on company value, TECH addresses the problem of technology ETFs being based on overvalued stocks. But relying on Morningstar’s equity ratings adds another layer of active management and a different risk profile compared to traditional market-weighted ETFs. The MER of 45 basis points for this kind of ETF is reasonable.