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One of my favoured strategies is buying out-of-favour sectors through index funds. Rather than pick companies in an unloved sector, I “buy the sector” with an Exchange Traded Fund (ETF).
Yes, this strategy is not as sexy as buying an undervalued company. Nor will you get much exposure to the “next big thing” because that stock is probably not yet in the index.
I know ETFs suit momentum/growth markets when everything is rising and are more challenging in falling, volatile market when active management is needed.
But using ETFs for tactical portfolio “tilts” has two main benefits. First, you mitigate company risk in volatile markets by owning dozens or hundreds of companies through an ETF.
Second, this strategy suits thematic investing, where investors have a strong view on a trend or sector, but less information on companies within it. For example, I like the outlook for cybersecurity, but would struggle to form a view on individual global cybersecurity stocks.
I used this ETF/sector strategy at the peak of the sharemarket sell-off in March 2020. Readers know I went bullish on the tech sector, suggesting a mix of tech ETFs and stocks.
The BetaShares Nasdaq 100 ETF (NDQ) was a preferred idea in my March 18 column (“Taking advantage of COVID turmoil”). NDQ is up 37% since then.
In late April, I took a contrarian view on Australia’s big banks, nominating the VanEck Vectors Bank ETF (MVB) as the best way to play a banking recovery. MVB is up about 25% since then.
These examples show the benefits of buying unloved sectors via ETFs. You won’t make as much money by spotting the next Xero, but you won’t lose nearly as much if the idea stinks.
If COVID is contained locally, 2021 could be the year of the unloved sector. That is, a year when gains in banks, energy, tourism and other battered sectors turn into something larger.
Chosen well, sector ETFs could provide handy gains in 2021. Just be sure to understand currency risk with unhedged global ETFs and the effect of a rising Australian dollar on returns.
Here are five top Exchange Traded Product (ETP) ideas for 2021:
MICH is the quoted version of the Magellan Infrastructure Fund, meaning it is actively managed, unlike passive ETFs that replicate an index.
Governments worldwide are pouring money into infrastructure to stimulate their economy. Also, an eventual recovery from COVID-19 in the United States and Europe will boost demand at airports, toll-roads and other infrastructure crushed by the pandemic.
Infrastructure investing requires a global perspective due to limited choices on ASX, and few are better at this sector than Magellan. MICH’s hedging eliminates currency risk, which is important given the galloping Australian dollar.
MICH returned -14% over one year to October 2020. That was well ahead of its benchmark index (down almost 20%) but little solace in absolute terms to retail investors. Over three years, MICH has returned an annualised 2.5%.
After a period of poor absolute performance, MICH should have a better 2021.
Chart 1: Magellan Infrastructure Fund
My bullish view on Australian banks is extending to global banks. They, too, were smashed during COVID and are suffering from downturns in the US and Europe.
BNKS provides exposure to 57 global banks, almost half of which (by market capitalisation) are in the US and Canada. Key holdings include Bank of America Corp, Royal Bank of Canada, Citigroup and Wells Fargo.
Sensibly, no Australian banks are included in the ETF to avoid an overlap with direct bank holdings among Australian investors.
BNKS returned -20.5% over one year to end-November 2020. Over three years, it has an annualised total return of -7.81%. Global banks have been a shocking sector to own.
But every ETF has its price. BNKS is up 13% over three months, thanks to a strong November. Positive vaccine news has boosted global banks and investor sentiment towards them.
Assuming COVID is more contained in the US and Europe, global banks should have a good 2021 and start to reverse three years of terrible underperformance.
Chart 2: BetaShares Global Banks ETF
IXJ has been a preferred ETF for several years, mostly because I view healthcare as a core portfolio exposure for long-term investors.
COVID is quickening healthcare trends. Witness the boom in telehealth as medical practitioners treat more people online. Or growth in software-as-a-service health companies. Or the incredible potential of big pharma as gene-editing technologies revolutionise drug discovery.
IXJ provides exposure to 1,200 global healthcare companies. Eight of its top 10 holdings are US healthcare giants, including Johnson & Johnson and Pfizer.
IXJ returned 3.1% over 12 months to end-November 2020. Over 10 years, IXJ’s annualised return of 16.6% shows the benefits of having long-term exposure to global healthcare.
COVID has provided an opportunity to enter the sector. The ETF is unhedged for currency movements, so Australian investors need a view on our currency before buying IXJ.
Those seeking to eliminate currency risks could use the BetaShares Global Healthcare ETF (currency hedged).
Chart 3: iShares Global Healthcare ETF
During COVID, few sectors were as battered as global energy. A collapsing oil price, global recession, geopolitical shocks, the pandemic … on it went for energy companies.
FUEL fell 33% over one year to end-November 2020. Over three years, the ETF has returned almost -13% annually. Global energy has been a woeful underperformer.
That should change as the global economy slowly recovers from COVID and as more capital rotates into undervalued energy stocks.
FUEL provides exposure to 36 of the world’s largest energy companies, including Chevron, Exxon Mobil, BP and Royal Dutch Shell.
If, like me, you expect the global economy to reflate next year as COVID is contained, energy is a go-to sector. Currency-hedged exposure to the world’s best energy companies appeals.
Chart 4: BetaShares Global Energy ETF
Global economic recovery, vaccine distribution and a weaker US dollar suggest the recent rally in emerging-market risk assets could go up a few notches in 2021.
I favour active emerging-market funds, such as FMEX, over index funds for exposure. Emerging markets are too volatile to take an index-only approach.
Available via ASX, FEMX is the quoted version of the Fidelity Global Emerging Markets Fund. It invests in 30-50 companies in the region, with a bias towards China, Taiwan and India.
FEMX returned 11.4% over one year to end-November 2020, a few points above its benchmark.
Emerging markets have rallied since global sharemarket lows in March 2020. Gains will be slower from here, but I like the 2021 prospects for emerging-market equities, particularly as the US dollar continues to weaken next year.
Chart 5: Fidelity Global Emerging Markets Fund