Mar 29, 2017

Daniel Straus' Top Picks: March 29, 2017

BNN Bloomberg

Daniel Straus , BNN

Daniel Straus, head of ETF research and strategy at National Bank Financial

Focus: ETFs
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MARKET OUTLOOK
Even as political uncertainty threatens to unsettle the direction of many markets, investors have been piling assets into ETFs of almost every flavour and asset class. ETF providers have been keeping pace with a record number of product filings, launches, and entrants. Canadian ETF assets are at $120 billion, with over $4 billion in flows year-to-date. Major asset managers such as Manulife, Desjardins, and Franklin Templeton have all signaled their intention to enter the ETF market by filing for new ETFs, and in 2017 we’ve seen the entrance of new players like Redwood and also Dynamic, which partnered with iShares to launch actively-managed ETFs.

To construct an ETF portfolio, we begin with National Bank’s asset allocation views from our Economics and Investment Strategy Team. These are broad and diversified asset allocation schemes with six basic asset class lines: Canadian, U.S., and international equities, bonds, alternatives, and cash. We take two specific directions for exposure in each asset class:

Passive Core: for broadest and least expensive exposure
Strategic Satellite for factor-based or actively-managed exposure

Breaking down the outlook by asset class:

GLOBAL EQUITY
Our strategists are seeing an improving global economy with many indicators (Global PMI, industrial production, trade volumes) topping consensus. Rising trade protectionism remains a risk that threatens an otherwise positive outlook. Overall, they like that most equity market returns year-to-date have been driven by earnings growth rather than P/E expansion.

CANADIAN EQUITY
Canadian investors should always be mindful of the “home bias” in their portfolios. Canada forms only three to four per cent of the world equity market, so any allocation to Canadian stocks above that small sliver might constitute a bias beyond what the “efficient market hypothesis” would dictate. However, given that many Canadian investors have 60 per cent or more allocated to Canadian stocks, we find that a simple one-third starting point for each of Canada, the U.S., and international equity makes sense as a corrective measure.

The Canadian stock market has always been concentrated in banking and resources, and our strategists are seeing leadership in financials (35 per cent of the S&P/TSX) and materials (13 per cent), with energy (20 per cent) acting mainly as a drag. Taken together, these sector concentrations make for an uncertain picture with limited upside until the U.S. softens its protectionist rhetorical stance.

U.S. EQUITY
The past few months of U.S. market activity suggest that investors are believers of the three-pronged approach of deregulation, tax reduction, and infrastructure spending. Our economists and strategists, however, are neutral on the world’s largest economy, because the political will for economically-detrimental policy (trade protectionism and immigration roadblocks) remains a persistent source of risk.

FIXED INCOME
In general, bonds are at risk as yields may rise in light of a pickup in inflation. With December’s Fed rate hike in the rear-view mirror and further tightening on the horizon, our strategists are suggesting shorter-term products with higher credit exposure where risk-appropriate.

TOP PICKS

(These aren’t “Top Picks” in the sense of a portfolio manager running an actual portfolio, but are rather example selections from our model portfolio report.)

HORIZONS SEASONAL ROTATION ETF (HAC.TO)
Our model portfolios allow for a small allocation (typically five to 10 per cent) towards “alternative” assets as a measure of risk control. Ideally, alternatives should be uncorrelated with both stocks and bonds so that their inclusion would improve the long-term, risk-adjusted returns of a portfolio. With this in mind, one can consider several classes of assets as “alternative investments” for the purpose of portfolio investing: real estate, commodities, private equity, hedge funds, and even gold. HAC is not outwardly branded as a hedge fund ETF, but its active trading strategy is quite “hedge fund like” and its performance profile bears this out. HAC seeks to deliver long-term capital appreciation by tactically allocating among equities, bonds, commodities, currencies, and derivatives, using both long and short positions.

VANGUARD US TOTAL MARKET INDEX ETF (VUN.TO)
Many investors think of the S&P 500 as the main benchmark for U.S. equity exposure, and indeed we use it as the U.S. reference index in most of our portfolio analysis. However, all 500 of the companies in this index are large cap, meaning that you might be missing out on essential mid-cap and small-cap exposure with an S&P 500 ETF alone. VUN (through its underlying U.S.-listed ETF VTI) holds over 3,500 companies. Eighty per cent of VUN overlaps with the S&P 500 anyway, so with its fee of 0.16 per cent we see it as a very low-cost, efficient way to gain total U.S. market exposure as a core position in the portfolio.

ISHARES EDGE MSCI MINIMUM VOLATILITY EAFE INDEX ETF (XMI.TO)
With the U.S. beset by political uncertainty and Canada at the whim of larger forces such as rate hikes, trade agreements, and the price of oil, many investors are looking at the rest of the developed world for their equity opportunities. This ETF is part of the crop of “low volatility” ETFs, which might be a helpful way to build a portfolio of companies that can weather coming storms.