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Riding the share market rollercoaster

ETF Watch - Nov 07, 2018

The month of October 2018 saw volatility return to global share markets. With fairly benign conditions for a few years now, it did not take long for doom and gloom headlines to dominate as markets fell by anywhere from 10 – 20%. Markets may have stabilised for now but for how long? We take a look at the ETFs and LICs most affected by the falls, and some strategies available to help investors ride out the volatile times.

What caused the volatility?

October has a certain infamy about it, with some of the largest share market falls in history (2008, 1987, 1929) all occurring in the month of October. Its easy to blame the latest falls on the ‘October Effect, however statistics don’t lie, and October statistically has no more down days than other months, so one needs to look a bit further than a tin foilesque theory based purely on earth’s orbit around the sun.

Many are blaming the falls on a more sound theory of rising global interest rates. Whilst locally our interest rates have not moved in some time, in the US it is a different story, with interest rates continuing to rise as the economy improves. The US Federal Reserve has signalled three rate rises next year, which has spooked investors.

Whatever the cause of the market falls, corrections in equity markets are not unusual, and can be fiercest after periods of low volatility, where complacency tends to set in. It can take a small trigger to swing the momentum, which can then self perpetuate as greed turns to fear.

Which sectors were most affected?

Technology

The market darling of the last few years, the high growth technology sector took a battering in October. Both Netflix and Amazon were down around 20% and most tech companies did not escape unscathed.

Closer to home, the ETFs that are exposed to the global tech space have all seen large falls from peak to trough. The largest of the tech focused ETFs, the Betashares NASDAQ 100 (NDQ) and ETFS Morningstar Global Technology ETF (TECH) saw 11% and 14% falls respectively. The more thematic offerings within this space such as the ETFS ROBO Global Robotics and Automation ETF (ROBO) and BetaShares Global Cybersecurity ETF (HACK) saw larger falls of 16% and 14% respectively, whilst Betashares are probably wishing they delayed two of their latest listings by a couple of months, with their Global Robotics and Artificial Intelligence (RBTZ) and Asia Technology Tigers (ASIA) ETFs falling by 17% and 16% in their short life.

Leveraged ETFs

Not surprisingly, leveraged ETFs, who use internal borrowing to amplify returns saw their losses amplified during the period of market volatility. The Betashares Australian and US Equity Funds (GEAR and GGUS) saw 25% and 23% losses as fear gripped markets. An important reminder that the use of leverage can be a double edged sword, with both gains and losses magnified.

Listed Investment Companies (LICs)

Here at ETF Watch, we follow both ETFs and LICs. We currently follow 186 ETFs and 93 LICs. Whilst there are twice as many ETFs as LICs available, 13 of the 20 funds with the largest falls during September & October were LICs.

This does not imply that the LICs performed poorly, however highlights the unique structure of LICs, where prices are determined by the supply and demand of the LIC, rather than the underlying assets. It could be that many of these LICs have performed quite well, but the fear in the markets has seen their price fall by much more than their performance. We’ll take a closer look at how LIC Net Asset Values (NAVs) have fared lately in a later post.

What sectors have survived the rout unscathed?

Currencies

The Australian dollar has been in a falling trend for some time against major currencies, particularly the US Dollar. Peaking at over $0.80 US in January, and falling to a low of about $0.70 in October, this has helped soften the blow to investors in global markets.

Of course the currency focused ETFs such as the Betashares US Dollar ETF (USD) has performed well for Australian investors during this period.

Gold

Gold is seen as the ultimate hedge against uncertain times, with investors tending to flock to this asset class when markets fall. For Australian investors, it has the added benefit of being quoted generally in US Dollars, so when the Australian dollar tends to fall in times of market turmoil, and gold prices go up, investors get the double whammy of gains through gold price appreciation and currency depreciation.

However, gold has been on a downward trend in US dollar terms. It has seen a small bump recently, but most of its performance gains over the last year have been due to the falling Australian dollar.

Investors can gain access to gold through a few ETFs. The ETFS Physical Gold ETF (GOLD) and Perth Mint Gold (PMGOLD) both provide pure exposure to gold, and have returned around 5% over the last year, or about 12% during the trough to peak during the recent volatility. For access to currency hedged gold exposure, the Betashares Gold Bullion ETF – Currency Hedged (QAU) is the only option available. QAU hasn’t had that exchange rate exposure so as not performed as well as the other options, but for investors that think the Aussie dollar doesn’t have any more to fall, this may be a more lucrative option.

Inverse ETFs

Inverse ETFs move in the complete opposite direction to the main markets. Investors in these funds are betting on markets moving down. We took a look at Inverse ETFs in an earlier post.

Of course, these funds have done well recently, with Betashares Australian Equities and US Equities Strong Bear ETFs (BBOZ & BBUZ) adding 21% and 19% respectively from peak to trough. These two funds are actually internally leveraged to falls in market, amplifying their gains and losses as the market goes up and down. The non leveraged Australian version, BEAR, returned 10% from peak to trough.

Of course these types of ETFs should not be seen as long term investments, as markets inevitably go up in the long term, rather they are tools to take advantage of market volatility or help hedge portfolio losses.

Fixed Income and Cash ETFs

Harry Markowitz created modern portfolio theory to help risk adverse investors to construct portfolios to maximise portfolio returns based on a certain level of market risk. The market risk in his theory which has been used in portfolio construction for over 60 years is the exact risk we have seen of late, the short to medium term ups and downs in markets which make it hard for some investors to sleep at night.

Its no surprise then, that a portfolio constructed for risk adverse investors using the principles behind Modern Portfolio Theory generally has high weightings to both fixed income and cash, both of which are low in volatility and help to smooth out portfolio returns.

Whilst threats of rising interest rates have seen fixed income focused ETFs fall a bit of late, these falls have generally been capped at 2-5%, compared to 12-15% for equities. Cash is cash and investors willing to accept the low yield of cash are rewarded with stable portfolios. There’s too many Cash and Fixed income ETFs available now to list, but a search of the ETF Watch fund database will help narrow down the search.

How to survive the rout and ride the rollercoaster?

Any of the above strategies may be used to soften the blow of share market falls. Gold, currencies, inverse ETFs, fixed income and cash are all tools readily available to help. The great thing about the growth of ETFs is that these tools are all available with just a single share market trade.

However, as boring as this sounds, the best way is often to close your share trading apps and let the magic of time be your friend. The below chart shows a $10,000 investment in Australia’s oldest and largest ETF, the SPDR S&P/ASX 200 (STW) Fund on a the day of listing in August 2001. Weeks before the 911 terrorist attacks, a few years before the global financial crisis and weathering everything that has come since.

 

Ignoring the short term volatility, across the 17 or so years the performance above follows a rough upward sloping line. The initial $10,000 investment would now be worth around $25,000 if all dividends were reinvested (and ignoring the benefit of any franking credit refunds). Most importantly, the recent volatility is just a small blip in the chart and will likely be soon long forgotten.

In investing time really is your friend. The rollercoaster ride can be part of the fun.

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