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Investing for the recovery with ETFs

Anthony Fensom  |  22 Sep 2020Text size  Decrease  Increase  |  
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Financial markets have proven surprisingly resilient to the coronavirus pandemic, with stocks boosted by fiscal and monetary stimulus measures despite a global recession.

Now with prospects for a vaccine improving, how might investors position themselves for the anticipated recovery?

“The first point is it’s important to consider whether the more positive outlook is already reflected in market expectations and valuation of securities,” said Tim Wong, director, manager research at Morningstar Australasia.

“Assuming that investors are confident that isn’t the case, the natural starting point would be exposure in equities, assuming this scenario leads to revised upwards corporate earnings growth. There are plenty of different ETFs [exchange-traded funds], passive and actively managed that would work well in that scenario.

He added: “We generally think you’re better off in more diverse exposures. There are more specific commodity or sector ETFs that are out there … but those narrower ETFs can have risks that can exceed investors’ tolerance and the more niche ETFs can be small and costly to trade.

“In terms of the more diverse ETFs, for Australian equities there are plenty of options. The Australian sharemarket is relatively pro-cyclical by global standards given the dominance of financials and materials, so that exposure would provide benefits under those conditions.

“On the global equities side of things, investors could own some heavyweight consumer and IT companies for example that aren’t available in the Australian market.”

Different scenarios

For those expecting a rapid “V”-shaped recovery, Morningstar’s “aggressive” model portfolio with its 90 per cent exposure to growth assets (shares and listed property) highlights some potential investments.

Targeted at investors with a nine-year timeframe or those willing to accept high levels of volatility, the fund’s asset allocation as at 30 June 2020 comprised 45 per cent international equities and 30 per cent Australian equities, with a 7 per cent weighting to fixed interest and 6 per cent to international listed property.

Top holdings included the silver-rated Vanguard MSCI International (Hedged) ETF (ASX:VGAD) (18 per cent portfolio weighting), followed by the bronze-rated SPDR S&P/ASX 200 ETF (ASX:STW) (15 per cent) and silver-rated Magellan Global Equities ETF (ASX:MGE) (10 per cent).

In contrast, investors anticipating a slower “U”-shaped recovery could consider a less volatile portfolio such as the Morningstar “growth” model portfolio, with a 70 per cent exposure to growth assets, or the “balanced” portfolio with an equal exposure to growth and income assets.

For the balanced portfolio, fixed interest accounts for the largest asset allocation at 30 per cent, followed by international equities (24 per cent) and cash (20 per cent).

Top holdings at 30 June 2020 comprised the neutral-rated BetaShares Australian High Interest Cash ETF (ASX:AAA) with a 20 per cent portfolio weighting, followed by the silver-rated iShares Core Composite Bond ETF (ASX:IAF) (18 per cent weighting) and VGAD at 10 per cent.

Investors anticipating a “L”-shaped recovery could consider the asset allocation strategy of Morningstar’s “cautious” model portfolio, with a 70 per cent exposure to cash and fixed interest and 24 per cent to equities, or the even more cautious approach of the “conservative” portfolio with an 85 per cent exposure to income assets.

For both portfolios, the top holdings comprise AAA and IAF.

Other options for investors expecting further turbulence ahead could include safe haven assets such as gold, which is the focus of the BetaShares Gold Bulletin ETF – Currency Hedged (ASX:QAU).

Recession investing

Although Australia’s stockmarket has lost ground this year, the nation’s first recession since the early 1990’s does not necessarily mean hard times for investors.

According to a 2011 Vanguard study, returns for balanced portfolios do not greatly differ in recessionary compared to expansionary periods. Somewhat counterintuitively, the study found that holding equities can outperform bonds during downturns.

During calendar year 1990, the ASX All Ordinaries Index fell by 23 per cent as recession loomed. Yet during the four quarters of actual negative growth, the index gained nearly 13 per cent.

Vanguard Australia’s Robin Bowerman warns that investors typically sell in the early stages of a recession, missing the recovery.

“Timing is made even more difficult by the fact that some of the market’s best days are found in years with negative returns,” he wrote in the Australian Financial Review.

The suggestion from Bowerman is for investors to “hold their nerve, stay invested, avoid succumbing to the temptation of market timing and focus on the things within their control,” like tightening discretionary spending.

Capital Economics expects “risky” assets such as shares to resume their outperformance of “safe” ones such as bonds, providing the global economy continues its revival.

With Australia’s economy expected to emerge from recession in 2021, holding your nerve appears to be sound advice ahead of the likely post-pandemic upturn.

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

is a Morningstar contributor.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

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