Inside ETFs Canada eMagazine 2020
Inside ETFs Canada went digital this year and brought the most exciting content, specialized networking, and latest product launches right to your home...
Inside ETFs Canada eMagazine
Canada's home for ETFs.
A Light in Uncertain Times
Erin Wolfe of Inside ETFs reviews the content from Inside ETFs Canada 2020
Inside ETFs Canada went digital this year and brought the most exciting content, specialized networking, and latest product launches right to your home screen! This year’s content was new and fresh – covering all the latest market innovations and trends within the Canadian ETF space. Erin Wolfe, Conference Producer, Inside ETFs Canada gives the low-down on what went on.
After such an unprecedented and challenging year, how have ETFs fared? Where have the inflows and outflows been? With the presumptive win of Joe Biden, how should we expect the economy to respond? In uncertain times, we need tangible answers and our cast of industry leaders certainly offered some much-needed insight.
Day one
Steve Hawkins of CETFA kicked off day one with positive projections in the ETF space, followed by an in-depth review of the year by Women in ETFs. WIE’s Tammy Cash led a panel of top female panelists, including Kalee Boisvert of Raymond James, Vivian Hsu of Fidelity, Sucheta Rajagopal of Mackie Research, and Dina Ting of Franklin Templeton, discussing how the NAV deviations in volatile markets have affected trading and how using ETFs has insulated client portfolios from concentration risk.
We finished off day one with Brian Levitt of Invesco who discussed the major themes that will remain the same in the space regardless of who wins the presidential election.
Day two
As we began Day two, Philip Lawlor of FTSE Russell gave us an overall outlook on what’s to come for Canada. Then Todd Rosenbluth and panelists Mike Philbrick of Resolve Asset Management, Tyler Mordy of Forstrong, and Martin Lefebvre of National Bank of Canada, shared insight into the global trends we should see into 2020 and beyond.
Another area to note is the ever-evolving landscape of ESG. ESG is a rising topic within the industry that can leave investors perplexed as it addresses the right kind of investments they should be making. How do we quantify these assets? How do we choose the right assets to add to portfolios to meet investors social and financial goals? Are the investments we’re making SRI, ESG, or Impact Investing and how do you tell the difference? Luckily, Inside ETFs Canada brought you the best minds in the ESG space to help answer these very questions, including Martin Grosskopf of ESG as he explored the evolution of ESG, and the potential growth opportunities associated with these products.
Later in the day, Pat Dunwoody of CETFA led a panel discussion with Judy Cotte of ESG Global Advisors, Guilermo Cano of MSCI, and Linda Ma of National Bank of Canada dissecting the different areas of ESG to help us to understand the specific classifications surrounding these products. Day two continued with an ESG focus and a panel led by Anita Sharma of BNN Bloomberg with Margaret Dorn of S&P Dow Jones Indices, David O’Leary of Kind Wealth, and Mary Hagerman of Raymond James exploring the best ways to integrate these products into client portfolios.
Inside ETFs Canada also featured a panel presented by Davis Janowski of WealthManagement.com in tandem with experts Jeff Gans of Purpose Advisor Solutions, Clive Cholerton of Quintessence Wealth, and Robert Di Iorio of RBC Dominion securities, reviewing the key technologies you need for your business and how best to integrate these systems to provide a more user-friendly experience for clients.
A Financial Advisor’s Guide to Thematic Investing
Global X take a deep dive on an approach that is increasingly attractive for investors.
While thematic investing is not a new investment approach, recent trends show that investors are increasingly incorporating this long-term, growth-oriented strategy into their portfolios. Since 2015, assets in thematic ETFs have grown more than eight-fold, with total assets under management (AUM) inching close to $60 billion (USD) at the end Q3 2020.
What is thematic investing
The rapid pace of technological advancement, the emergence of powerful demographic trends and changing consumer habits, and evolving demands and concerns around the physical environment are creating massive opportunities for disruption across the global economy.
Thematic investing refers to the process of identifying these powerful macro-level trends and investing in the companies that stand to benefit from their materialization.
It is our belief that thematic investing, when conducted properly, should meet three key criteria:
1. High Conviction
Themes should have a high probability of disrupting major segments of the global economy.
2. Investability
There should be dozens of publicly traded companies that have high exposure to the particular theme.
3. Long Time Horizon
The theme should be structural in nature, taking decades to fully emerge.
Why Incorporate Thematic Investing in Clients’ Portfolios?
There are three main reasons to include thematic investing in investors’ portfolios:
1. High Growth Potential
Thematic investing targets companies that are poised to benefit from the emergence of powerful structural trends. These companies tend to have higher growth characteristics than broad market indexes, like the S&P 500 or even the Nasdaq 100. For long-term investors with more aggressive portfolios, thematic investments can potentially improve growth expectations, serving in a complementary role alongside a diversified core.
2. Embrace the Next Wave of Disruptors
The companies that dominate broad market indexes and sector indexes tend to be winners of the past: companies that already experienced rapid growth and delivered superior shareholder returns. But just like today’s leaders disrupted corporate powerhouses from the 1990s and early 2000s, tomorrow’s leaders are likely to be a new group of companies developing revolutionary technologies or catering to new consumer preferences. Thematic investing helps identify these companies early in their disruptive journey, providing investors exposure to tomorrow’s potential leaders.
3. Connecting with Clients Across Generations
Over the coming decades, Baby Boomers are expected to pass $30 trillion to their heirs. At the same time, Millennials are reaching higher income brackets and will represent a majority of the labor force. These demographic shifts create both challenges and opportunities for financial advisors. On one hand, many Baby Boomers are looking to preserve and grow their wealth far beyond their own lifetime. On the other hand, wealth will increasingly be concentrated among Millennials, a tech savvy generation with distinct preferences that are often very different from those of their parents. Thematic investing can play an important role by bridging the gap between generations by helping to build multi-generational wealth over the long term, while also appealing to Millennials’ interests.
Where do ThematicETFs fit in a portfolio?
ETFs can be an efficient vehicle for accessing powerful disruptive trends. In a single trade, a well-designed thematic ETF can provide access to dozens of companies around the world that are likely to benefit from the rapid growth of a particular theme. This can save investors time needed to research potential themes and companies, as well as transaction costs from trading many securities across various geographies.
Due to their focus on high growth stocks and the long-term nature of thematic investing, we believe that thematic ETFs should be included at levels that are appropriate for an investor’s risk tolerance and time horizon.
Specifically, we believe investors may be well-served by carving out a portion of their portfolio’s equity exposure to create a dedicated thematic growth bucket.
Depending on market conditions and the investor’s time horizon, within a conservative or moderately conservative portfolio we believe that a thematic allocation in the range of 2% to 6% is currently appropriate.
A higher level of thematic exposure becomes appropriate as an investor’s time horizon and risk tolerance increases. Within moderate to aggressive risk profiles, we believe that an allocation in the range of 10% to 23% is currently appropriate.
This dedicated thematic growth bucket ought to contain a handful of different thematic ETFs that have low overlap with each other and the portfolio’s other equity exposures.
Diversifying the thematic exposure is important as themes perform differently depending on market conditions. Due to these themes being long-term in nature, it is preferable to have a buy-and-hold approach to the thematic growth bucket.
Why partner with Global X ETFs for Thematic Investing?
Global X ETFs is a leader in thematic investing, offering a comprehensive suite of rigorously designed, research-driven thematic ETFs. Global X first entered the thematic space more than ten years ago, and has since developed over a decade of experience researching, designing, managing, and supporting thematic ETFs.
Our thematic offering currently includes 23 ETFs, the largest and most comprehensive suite of thematic ETFs in the United States.
Global X’s commitment to thematic investing goes beyond launching ETFs. We support our products with extensive thought leadership, from insightful research, to actionable model portfolios.
For Canadian investors, please reach out at this dedicated email address: Canada@globalxetfs.com
Creating a culture: more than happy hours and ping pong tables
Clive Cholerton, Executive Partner, QWealth Partners, Quintessence Wealth.
A few years ago, I visited a very successful Wealth Management firm in Atlanta. The firm was in excess of 3B AUM, had incredible growth rates, and were looking to enhance their client experience and technology solutions. Which explained my visit.
It was, without question, the most beautiful financial planning office I had ever seen. The lobby contained a focal point wall with handcrafted Georgian stone, and a fully functioning - though somewhat superfluous, (it was Atlanta, in November) - fireplace. Off to the side of the lobby, was an enormous staff area.
It was designed with built in lounges, sofas, and various seating areas, presumably intended to create a welcoming environment for staff to congregate, discuss ideas, and collectively bask in the glory of acknowledging how successful they were.
To the right, a coffee bar was fully equipped and decked out beyond anything you would see in an upscale, pretentious, Seattle coffee house. To the left, perfectly aligned with the contours of the room, was the Ping Pong table: Screaming to the world, “How cool are we?”
The room was entirely empty. They built it, and no one came.
I spent a few hours in the office. Met the executives, presented our technology, and spent time with the staff. The team was, to a person, exceptionally bright, knowledgeable, motivated, and entirely… “disengaged”. They performed tasks in their individual silos, talked about the other silos in hushed tones, hinted at turf wars that waged barely below the surface, and rolled their eyes at the idea that our technology solution could improve their company because, as one manager put it, “well that would be amazing, but I’m not sticking my neck out to have it chopped off”.
A step back: Years ago, the noted anthropologist Margaret Mead was asked by a student what she considered to be the first sign of civilization. Clay pots? Tools for hunting? Religious artifacts? Her response: “The first evidence of civilization was a 15,000-year-old, fractured, femur found in an archaeological site. In the animal kingdom, if you break your leg, you die. You cannot run from danger; you cannot drink or hunt for food. Wounded in this way, you are meat for your predators. No creature survives a broken leg long enough for the bone to heal. You are eaten first. A broken femur that has healed is evidence that another person has taken time to stay with the fallen, has bound up the wound, has carried the person to safety and has tended them through recovery.” The metaphor speaks for itself. Clearly, culture within any organization, is simply a microcosm of an extended ‘civilization’. Culture starts and ends with caring. But, in between, are literally hundreds of daily, repeated rituals that reaffirm who you are, what you value, and the basic principles on which you conduct yourself daily.
Who you are?
Inherent with this self-reflective question is the extended question of “What do I want my company to be? If indeed, you want a company that “allows a broken bone to heal”, then you need to exhibit caring when your staff member or colleague stumbles, makes a mistake, “breaks a bone”.
What do I value?
Do I want a culture, that values simply ‘survival of the fittest’ or instead recognizes that when a broken bone heals, it heals stronger than the original? Rather than sacrificing strength and progress by allowing a ‘bone to heal’, on the contrary - the organization is stronger, more trusting, and overwhelmingly more engaged. It was actually one of my staff that pointed this nuance out to me. I almost cried.
Principles of Daily Activities.
This is where the rubber really meets the road. We’ve all attended countless conferences, where gregarious pronouncements of culture and team building are served up in healthy doses of nutritionally devoid platitudes. What redirects the platitudes to protein-rich actions are small steps. Day-over-day! It’s about articulating a vision that crystalizes a company towards what it does for others and not how it benefits the executives. It’s about creating strategic initiatives that link directly to that vision and rejoices in both the success and failures that come from that strategy, because that allows the bone to heal more strongly. Finally, it’s about the tactical work that links to the strategic initiatives, that links to the vision, that is done by the staff of your firm. The second that they feel, to quote our manager from Atlanta, “I’ll get my neck chopped off”, is the same moment you know, no Ping Pong table puts that ‘culture genie back in the bottle’.
Back to my Atlanta onsite: On my way out, the COO asked if I wanted to join the team for their weekly Happy Hour. I pictured disgruntled employees, fueled and emboldened by alcohol, venting their frustrations while clinging to their siloed turf wars. What could be better? Lucky for me, I did in fact have a flight to catch, affording me a plausible getaway.
My perspective continues to evolve in my current role as an Executive Partner of a National firm. I have a clearer sense of the importance of small actions determining much more about culture, than any trite, motto ever could. I am acutely aware that what is messaged to our partner firms sends a message, as much to our partners, as it does to our team who socialize that same message. I fiercely protect the consistency of that message. Finally, I find myself mentally juggling the business mantras of “effective leadership holds employees accountable” with “a broken bone will heal with more strength than the original”. I believe the two are not mutually exclusive, but I know with certainty which side I would err more towards.
Clive Cholerton is Executive Partner, QWealth Partners, Quintessence Wealth, based in Toronto, Canada.
He us a multi faceted Wealth Management background in the areas of Platform Development, Practice Management and Business Development.
A sought after speaker and industry expert. Dedicated to creating the premiere wealth management platform providing Canadians the most personalized, sophisticated and accessible financial experiences available.
Too much of a good thing? A closer look at Canadian home bias investing
FTSE Russell look at the phenomenon of 'home bias' and it's detrimental effects on investing.
Home bias—or the tendency to invest disproportionately in domestic equities—is a well-documented behavioral finance concept. Whether as a result of restrictions or complexities associated with investing in foreign equities, or simply a preference for investing in what is familiar, even some of the most sophisticated investors have demonstrated home bias. Too much home bias results in both security and industry concentration risks—and increasing exposure to international equities can improve diversification and significantly mitigate these risks.
Concentrated exposures in Canadian equities
If we use representative FTSE Russell indexes as proxies for Canadian equities and international equities, we can compare composition to get a better sense of exposures and potential risks. A closer look at the top ten constituents of Canadian equities and international equities demonstrates a material difference in security concentration. As shown below, the largest ten constituents by weight in Canadian equities constitute more than 40% of the index, while the largest ten constituents by weight in international equities make up less than 14%.
Adding international equities can not only improve security diversification, but can also offer greater diversification with respect to industry composition. As shown in the top 10 constituents table, international equities can provide diversification benefits through higher weights in global growth driver industries such as Technology and Health Care, and lower weights in the Financials, Basic Materials, and Oil & Gas industries that dominate the local Canadian market.
Top 10 constituents by weight
Adding international equities can not only improve security diversification, but can also offer greater diversification with respect to industry composition. As shown below, international equities can provide diversification benefits through higher weights in global growth driver industries such as Technology and Health Care, and lower weights in the Financials, Basic Materials, and Oil & Gas industries that dominate the local Canadian market.
Home bias pitfall: More risk, lower returns
If we look at Canadian and international equity performance since 2006, Canadian investors with a home biased equity portfolio would have experienced lower returns and higher volatility relative to a broader international equity portfolio.
As shown on the next page, international equities outperformed Canadian equities by more than 200 basis points on an annualized basis from January 2006–June 2020. And international equities also exhibited lower volatility for the time period, making for higher return/volatility ratios relative to Canadian equities.
International and Canadian equity return and risk: January 2006–June 2020
Risk/reward profile by weight in Canadian equities
How much home bias is the right amount?
For Canadian investors looking to add more international equity exposure for improved diversification, determining the right amount can be challenging.
To explore the optimal mix of Canadian and international equities, we conducted a hypothetical experiment in which we combined the Canadian and International portfolios at varying proportions and rebalanced them monthly. The chart on the right illustrates the return/volatility trade-off of these different allocations.
A perspective on Canadian equity allocation from Vanguard
At Vanguard, we are driven above all else by giving people the best chance for investment success. Our investment strategy research consistently shows us that the diversification benefits of combining local with international equities can improve investment outcomes for Canadian investors. This helps achieve balance in a portfolio, one of our four anchor investment principles (together with goals, cost and discipline).
The good news is getting access to high quality local and international equity exposure has never been easier for Canadian investors. As a leader in multi-asset solutions managing over $1 trillion in this way globally, Vanguard launched the first Canadian asset allocation ETFs back in 2018 to give investors a low-cost, diversified portfolio in a simple single-ticket purchase. The equity in each of these products includes broad, all-cap exposure to both Canadian and International equities, with over 12,000 individual securities.
Vanguard asset allocation ETFs: Data as at August 2020. Please click to see the graph in full.
As well as being used by investors directly, the asset allocation ETFs have high adoption from advisors. Some use as satellite holdings to complete portfolios, while many use as a core holding allowing them to spend less time on day-to-day portfolio management, and more time with clients on relationship management and behavioral coaching. Vanguard’s proprietary Advisors Alpha® framework shows this can result in even better investment outcomes for advisors and clients alike.
FTSE Russell index analyses indicate that diversifying with more international equities can help improve risk and return outcomes.
For more index research and information, please visit ftserussell.com or contact us at info@ftserussell.com.
For important legal disclosures, please click here.
Video: How ESG indices approve on the downside with Morningstar
An exclusive interview with Robert Edwards, Product Manager EMEA - Indexes at Morningstar
We speak to Robert Edwards, Product Manager EMEA - Indexes at Morningstar, focusing on how the upheavals of 2020, from the global pandemic to the Black Live Matter-movements, as well as the ongoing climate change, have helped ESG investing into the mainstream, but how ESG also requires that investors expand their toolkits.
For more insightful and industry-ahead thought leadership from Morningstar, please join us for one of the most highly-anticipated webinars of the end of the year on December 8. As we prepare to look back on 2020, let's take stock of the past 12 months and look towards the future that 2021 holds for us as investors.
Factor behaviours during corrections and recoveries
Fidelity look at using factors to navigate through volatile markets
The S&P 500 Index peaked on February 19, 2020, as the global COVID-19 pandemic became a market reality. The outbreak would end arguably the longest bull market in history, which began after the global financial crisis in 2008.
The combination of a supply shock to the oil market and global supply and demand shocks was unusually severe. What ensued was an extremely sharp correction, with the S&P 500 Index falling by 23.5% (USD) by March 31, 2020, and similar corrections across the globe. Although markets have recovered from their troughs, it is still unclear what the future holds.
During this time, investors have experienced a gamut of emotions, ranging from fear and panic to hope and optimism. It has become clearer than ever that investors need to plan, and not just react. We all know that markets go up and down, that recessions come and go – and that if you have a long-term time horizon, there are ways to achieve strong risk-adjusted returns in all environments. The important questions are, “How is my portfolio positioned to mitigate additional downside risk?” and “How can I position my portfolio to participate in a recovery?”
The study of equity style factors, which include dividend yield, low volatility, quality, value, momentum and size, offers some answers to these questions. Equity style factors have been empirically researched for many years, and have been shown to outperform the broad market over the long term. Allocations to these factors can help provide flexibility and stability in tailoring a portfolio to investors’ specific investment goals.
Factor performance during the drawdown phase
Looking back to 2000, there were six occasions on which the S&P 500 Index experienced a drawdown of 10% or more, including the current correction.
Historically, equity factor performance has varied, depending on the market environment, and because not every correction is the same, and the catalysts may differ.
On average, however, defensive factors such as low volatility, dividend yield and quality have typically outperformed.
(Re)positioning for the recovery
Historically, all the factors participate in the rally as markets rebound, but to differing degrees. Size and value tend to outperform the broad market, in the three, six and twelve months following the trough of the corrections. This is probably because small-cap stocks tend to underperform during a correction but then outperform during the recovery: they carry more risk than large-cap stocks, and therefore tend to benefit when investors’ risk appetite increases. Value stocks, meanwhile, typically include stocks that have become inexpensive or beaten-down, and can then outperform as economic growth turns positive.
Using factors as a tool for portfolio construction
We have a good idea of how equity factors behave in drawdowns and recoveries, but applying this knowledge to portfolio construction is no simple matter. It is very difficult to time the market from peak to trough and trough to recovery, especially with any consistency.
Equity style factors are used most successfully in combination, in a long-term investment plan that captures the potential of all of them. Investors can achieve their investment objectives in a variety of market environments, through opportunistic or strategic exposures to the factors.
Allocations to low volatility, dividend yield and quality factors tend to offer more protection and can be used to position a more defensive portfolio. On the other hand, investors who have a bullish outlook might favour allocations to the value and size factors, which have greater potential for upside participation after a market trough.
But markets can be unpredictable and volatile, especially in the short term. Accordingly, combining multiple style factors will not only add diversification to an investment portfolio but also offer more stable returns over the long term, regardless of what the market is doing.
If you would like to learn more about how factors behave during corrections and recoveries, read our latest whitepaper. For more information, please contact your financial advisor or visit fidelity.ca
Commissions, trailing commissions, management fees, brokerage fees and expenses may be associated with investments in mutual funds and ETFs. Please read the mutual fund’s or ETF’s prospectus, which contains detailed investment information, before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently, and investors may experience a gain or a loss. Past performance may not be repeated. The statements contained herein are based on information believed to be reliable and are provided for information purposes only. Where such information is based in whole or in part on information provided by third parties, we cannot guarantee that it is accurate, complete or current at all times. It does not provide investment, tax or legal advice, and is not an offer or solicitation to buy. Graphs and charts are used for illustrative purposes only and do not reflect future values or returns on investment of any fund or portfolio. Particular investment strategies should be evaluated according to an investor’s investment objectives and tolerance for risk. Fidelity Investments Canada ULC and its affiliates and related entities are not liable for any errors or omissions in the information or for any loss or damage suffered.
Does higher income always mean lower growth?
TD Asset Management speak on evaluating and rethinking the traditional relationship between growth and income.
In the world of investing, nothing is static. Theories and strategies that brought us success in the past may not always provide prosperity in the future. This year, global investors faced volatility of epic proportions as markets plunged to depths unseen in many years, only to recover much of the losses. With central banks around the world providing enormous amounts of stimulus to help the economy, asset managers need to pivot and think about new ways to generate returns. This includes evaluating and rethinking the traditional relationship between growth and income.
The balance of growth and income
Investors that traditionally relied heavily on bonds for income returns are now facing increased challenges to generate enough income as yields continue to be suppressed and are expected to stay lower for even longer.
Against this backdrop, negative yielding bonds now account for around 20% of total bonds outstanding, which means they are guaranteed to lose capital if held to maturity.
On the equity front, higher yielding stocks don’t often offer growth, and high growth stocks don't often pay dividends. Therefore, investors could run the risk of eroding capital upside by chasing yields on low growth equities.
In the face of COVID uncertainties and geopolitical tensions, how does one balance growth and income?
The answer could be found in an enhanced dividend strategy offered by TD Asset Management ("TDAM").
What options are available for this conundrum?
Launched just over a year ago, TD Active Global Enhanced Dividend ETF (TGED) was designed to resolve the specific challenges of balancing growth and income in the search for yield. The strategy behind addressing this challenge is to generate highly attractive income through a differentiated option overlay strategy. TGED, unlike many competitor products, uses a completely active approach in both selecting stocks and writing options.
This approach not only allows TGED to enhance income on high quality underlying stocks, regardless of whether they pay dividends, but does so without sacrificing long-term capital growth. Having said that, the ETF does not simply replace growth with yield, but rather focuses on total return. What's more, investors may benefit from a tax perspective as the collected option premiums are generally characterized as capital gains rather than income.
TGED seeks to deliver 4%+ annual yield to investors while investing in global high-quality businesses that are tied to secular growth trends and can compound free cash flow over time.
The benefits and shortcomings of a systematic covered call strategy
A popular investment strategy to generate additional income in an equity portfolio has been a systematic covered call strategy. If history is a guide, a covered call strategy can typically outperform in a sideways or downward trending environments. The chart below helps illustrate this relative performance. It depicts the yearly performance of the S&P 500 Index versus the same Index overlaid by a systematic covered call strategy, with the assumption of writing 2% out-of-the-money covered calls and resetting these options every month.
The systematic covered call strategy enhances the income in a portfolio by capping growth up to a 2% monthly gain in exchange for current income (i.e. the option premiums). During periods of lower volatility, this systematic strategy generates solid risk-adjusted return as the additional income enhances the portfolio appreciation if monthly market returns remain below 2%. However, if the market trends higher, as we have seen over the past decade, the systematic covered call strategy will still enjoy growth but can significantly lag the performance of the overall market.
Based on this dynamic, investors should expect that a systematic covered call strategy can add value in a weak market, but will underperform in a strong market. However, for TGED, the active ETF has demonstrated that it can add value in both market downturns and market rallies using a proprietary active covered call writing strategy.
How TDAM does it differently
At its core, TGED leverages the TDAM time-tested philosophy and process when selecting underlying stocks. The ETF would only own high-quality businesses that have sustainable competitive advantages, solid balance sheets, compounding free cash flows and be set to better weather difficult times like the first quarter of, 2020, and thrive in the long run.
In addition, TGED outperformance was attributable to our active approach to writing options rather than a systematic approach. Unlike systematic option strategies, we are very selective on timing, underlying holdings, strike prices, expiry dates and contract sizes. Each of these factors are analyzed based on thorough fundamental research of a particular business at that moment in time. In scenarios like February 2020 when volatility spiked, we could terminate an option contract earlier than maturity and start a new one at a much more attractive yield. While it requires significantly more work than a systematic approach, we aim to generate high income for investors today while keeping their long-term capital growth in mind.
On balance, TGED is in a unique proposition to tilt the balance of income and growth in the investors' favour. The ETF only holds high-quality businesses and uses an active approach to enhance income without sacrificing total return. Looking ahead, when facing the uncertain impact of COVID-19 on the global economy and the ongoing geopolitical risk, TGED can stand to benefit from a volatile environment as, generally speaking, the higher the volatility, the higher the option premiums and by extension, the more opportunities for an active investor.
Following the success of TGED, we are excited to have recently launched the TD Active U.S. Enhanced Dividend ETF (TUED), that uses the same active strategy and focuses purely on U.S. equities.
Have the biggest mega-caps run too far?
John Feyerer, Senior Director of Equity ETF Product Strategy, Invesco.
In 2020, U.S. equity markets have taken a path that few could have seen coming. As a result, the S&P 500 Index has become more top-heavy than it’s been in 45 years. Below, I explain why this is the case, what it means for investors — and what they can do to help mitigate this concentration risk while maintaining exposure to the companies that make up this well-known benchmark.
The S&P 500 Index is dominated by just five holdings
Since its low on March 23, 2020, the S&P 500 Index has fully recovered on the back of historic government and central bank intervention.1 Not only has the index turned positive for the year, it has now exceeded its Feb. 19, 2020 high.
During this year’s equity roller coaster ride, the five largest holdings in the S&P 500 Index – Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Alphabet (GOOG/GOOGL) and Facebook (FB) have shined brightly. The average year-to-date return among these largest five holdings is more than 38%,1 driven by the perceived safety of owning the biggest companies as well the importance of technology and communication services in the work-at-home/stay-at-home world suddenly thrust upon us by the Great Lockdown.
Why is this outperformance by the mega caps important? Like many benchmark indexes, the S&P 500 uses market capitalization to weight securities. This means that despite the significant number of securities that are included, the risk and return of the index — and of the traditional index funds that track it — is driven by the largest holdings. The dominance of just a few large holdings on overall risk and return is called “concentration risk.”
The recent run up in these “biggest of the big” companies has created a situation in which the S&P 500 Index is more top-heavy than it has been in 45 years. As of Oct. 31, the top five stocks accounted for nearly 23% of the weight in the S&P 500 Index, up from 16.8% at the end of 2019 and widely surpassing the 16.6% observed in December 1999 (which was in the midst of the final build-up before the technology bubble burst in March 2000).3
Benchmark indexes face historic levels of concentration risk
As shown in the chart below, the current concentration risk of the S&P 500 is only a few percentage points from the high of 27.7% reached in 1964.2 This amount of concentration risk is one that traditional passive investors haven’t faced in over four decades. When concentration risk is the simple result of market capitalization (versus, for example, the intentional choices of an active manager), it may leave investors vulnerable in a few different scenarios: when valuations mean revert, when new competitors have a negative impact on the top companies, when regulatory risk emerges, and when the market experiences a rotation into more cyclical stocks.4
Concentration risk: The concentration in the top 5 holdings is nearly 23%, a level not seen since 1975
While the S&P 500 has enjoyed a healthy total return of 73.4% (11.6% annualized) since late October 2015, these five names had an average total return of 256% (27.5% annualized), nearly three times that of the
S&P 500 Index from Oct. 31, 2015 - Oct. 31, 2020.4 Their valuations have also expanded to the point that the average price/sales5 and price/earnings6 ratios for the top 5 are now 2x (7.53 vs. 2.45) and 2x (43.76 vs. 25.35) versus that of the S&P 500 benchmark, respectively, as of Oct. 31, 2020.
Date range: Oct. 31, 2015 to Oct. 31, 2020. Source: Bloomberg, L.P., as of Oct. 31, 2020. An investment cannot be made into an index. Past performance is no guarantee of future results. The above companies were selected for illustrative purposes only and are not intended to convey specific investment advice.
Against an ongoing backdrop of strength for these market giants, as evidenced by second-quarter earnings announcements, it is important for investors to remember that there are countless examples from financial history that tell us that the largest companies as measured by market capitalization do not maintain that lofty perch years into the future. As of today, the five largest companies in the S&P 500 have an aggregate weight that is higher than at any point since 1975, when the likes of IBM, Proctor & Gamble, Exxon Mobil, 3M, and General Electric were the biggest of the big.
Consider an equal-weight approach
Investors looking to diversify away from these top-heavy benchmarks while still maintaining exposure to their holdings may consider an equal-weight approach. Equal-weight strategies weight each of their holdings equally, so that overall performance cannot be dominated by a very small group of companies. So, using the example of the S&P 500, each of the 500 index companies would represent approximately 0.2% of the portfolio in an equal-weight strategy.
The Invesco S&P 500 Equal Weight Index ETF – CAD (EQL) may provide a potential solution for those investors that may want to diversify their portfolio to help mitigate this concentration risk while still maintaining exposure to the S&P 500.
Important information:
The companies mentioned in this document were selected for illustrative purposes only and are not intended to convey specific investment advice.
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ESG 2.0 – A Post-COVID-19 Roadmap for the Evolution of ESG
A “Gentler Form of Capitalism” and Its Failure to Prioritize, by Martin Grosskopf of AGF Investments
One of the key challenges for Environmental, Social and Governance (ESG) investing, at least in its still-early stage, is that it has always been a movement in search of a philosophy. True, it has a goal: since the “mainstreaming” of ESG began in the early 2000s, it has sought to bring important social and environmental issues into the “market mentality” around risk and return. Lately, the movement has claimed some significant victories, including the push for climate change disclosures (such as those recommended by the Task Force on Climate-related Financial Disclosures), the recent movement towards stakeholder capitalism, and the newfound market appetite for funding all things ESG-related.(i)
The general tone of ESG throughout its history has been to encourage a gentler form of capitalism, but its underlying philosophy has been completely in line with the main tenants of the prevalent market philosophy – that markets are the most efficient way to allocate capital, at least over time, and that they will do so in an ultimately rational fashion that will eventually see the goals of ESG realized. Perhaps part of this conformism is simply practical; after all, underfunded pensions have little fiduciary room to do much more than tinker with the system.
The current crisis, however, presents an opportunity for a much deeper assessment of the role of markets, governments and, for that matter, ESG. Following only 12 years on from the last big public-sector intervention – the Great Financial Crisis (GFC) – events occurring in only a few short weeks have laid bare the limits of efficient-market theory and the market’s inability to perform its most basic function: deploying capital to its highest and best use. That is not only evident in the disconnect between equity market over-performance and dismal economic realities; it also lies in the failure of markets to prioritize issues such as healthcare capacity and environmental health over austerity. And this failure comes despite the mainstream emergence of ESG and its successes.
Clearly, some self-reflection is needed to recognize the limited capacities of ESG to effect meaningful change within the market dynamic, and also to address the balance between returns and social/environmental impact. Orthodoxies that evolved to reward shareholders (ESG-inclined or otherwise), including low tax rates, ever-increasing dividend payouts, low reinvestment and share buybacks, will need to be modified to reflect the reality of a government backstop and the social contract implicit in worker obligations.
If it functions only as an add-on to the prevalent market philosophy, ESG cannot inform on the balance between shareholder rewards and societal resilience. The COVID-19 pandemic, as the first truly global natural disaster of the modern era, has demonstrated that the current skew towards shareholders is exceedingly fragile, and changes are likely required that go far beyond the World Business Council’s acknowledgement of a stakeholder model.
Public Intervention Precedence – “Whatever It Takes”
In response to the COVID-19 crisis, governments have proven that when sufficiently motivated, they are willing to deploy apparently unlimited resources to address issues of social risk. Ideas that were viewed as fringe only months ago are not only accepted now, but rolled out on a scale that was once-unimaginable even by their proponents. Modern Monetary Theory, for example, challenged the conventional logic around government deficits and austerity. Over the past ten months, the International Monetary Fund notes that governments have deployed close to US$12 trillion in various measures not to defeat the virus – of which clearly there could be variants or recurrences – but to buy time for an underfunded health system to respond effectively. In the most dramatic instance, governments are directing funds to largely replace income for at least some workers, in effect providing a basic income provision.
If governments can demonstrably print and deploy money at will, then it suggests that “austerity” was something of a poor excuse for the significant social spending cuts we have seen over many years.
It also now seems untenable to argue that the extraordinary efforts governments have made to prevent COVID-related deaths should not also be taken to address other pressing social-environmental threats, such as hunger, air pollution, poor sanitation, and so on. For longer-tail issues such as climate change, it becomes less believable to claim that mitigation efforts cannot be funded or that the most impacted industries cannot be transitioned. In response to a natural disaster, and in a short period of time, society has shown the desire and means to radic
ally alter patterns of work and leisure. Science has in effect taken prominence in informing societal actions, perhaps foreshadowing a wider recognition of its vital role in dealing with climate change as a large-scale systemic risk.
What are the implications for ESG? A pain point for “ESG 1.0” is its current philosophical interlinkage with traditional market orthodoxy. Post GFC, there was ample evidence of “models behaving badly,” yet these models continued to inform asset allocation and investment decision-making in the following years.(ii) Consistent with its history, ESG has largely been applied as a modest adjustment to these models instead of a methodological alternative. For this reason, it has not really prevented or reduced systemic risk – as COVID-19 has made amply clear. Generally, ESG has been added to the lexicon of efficiency – supporting global supply chains, conventional asset allocation and low tracking error, and perhaps adding some alpha – but has not enhanced the systemic resilience in the meaning of scholar Nassim Taleb and increasingly hoped for in initiatives such as the Financial Stability Council.(iii)
That the early link between ESG and market philosophy was important is undeniable – if only because it legitimized mass adoption of ESG practices. However, if we learn anything from the last two crises, it should be that we are not likely to predict the next one, whether ESG is adopted more broadly or not, so this should not be the primary aim of “ESG 2.0” if we hope that it will contribute to societal and environmental resiliency. If they hold that hope in earnest, ESG practitioners will need to forcefully engage on the relative roles of shareholder, government and workers not just with each other, but also with the asset allocators and real decision-makers within their organizations. This will involve very tough discussions around margin-friendly “efficiencies,” the realism of return expectations and growth rates, and recognition of the heavy capital intensity of an energy transition.
ESG 2.0 – Building on the Past, Improving for the Future
If these discussions do evolve, some of the current tenets of ESG practice will change:
Broad recognition of ESG as a useful and early “alternative” data set – The origins of ESG data collection in the 1990s lied in the recognition by some, generally outside the mainstream, that conventional financial data did not measure the full cost or benefit of a company’s interaction with society and the environment. In fact, MSCI ESG research is based on the Intangible Value Assessment (IVA) developed by Innovest in the 1990s, which along with Jantzi Research (Sustainalytics) was an early harbinger of the increased measurement of intangibles generally within the market over the following 20 years (Figure 1). Broader usage of the data will ensure improved data and reporting, but will also enable broad recognition of the value of incorporating at least a portion of this alternative dataset into relative valuation and asset allocation decisions.
The linkage between ‘asset-lite’ business models and high ESG ratings will become obvious – A source of alpha for many ESG-oriented funds has been derived from the strong link between ‘asset-lite’ business models and high ESG ratings. Clearly firms that employ fewer people per dollar of revenue (lower human capital intensity) and who provide software or cloud services tend to have a lower direct operational footprint relative to those in manufacturing or retailing industries. The alpha associated with this linkage is likely to become obvious to market participants, making it less likely to be a source of alpha in the future.
The efficacy of “relative” scores will decline – So far, the relative performance of firms on ESG metrics has been meaningfully different. During the latest decline, companies with better ESG scores have outperformed. This reflects the reality that within any given sector, some companies are taking ESG risks and opportunities seriously and devising explicit strategies to improve or capitalize. Over time, however, the tendency in any industry is towards convergence on issues that are viewed as material.
For example, if board diversity really is a strategic advantage, all companies will tend to adopt diversity practices. So, imagine a future in which all boards are diverse – and then imagine trying to distinguish materiality among diversity strategies. Or consider climate change. The years of fighting a rearguard action for resources companies will likely morph into credible – and widely adopted – strategies for reducing their carbon footprint and assisting with the energy “transition” (lower emitting sources). Whether used for long-only strategies or those employing shorting, over time the efficacy of a simplistic interpretation of ESG data points is less and less likely to be meaningful.
ESG progress will be defined as co-operation, not competition –
As the COVID-19 pandemic has demonstrated, systemic risks such as natural disasters cannot be addressed competitively at the company level. Inter-company rivalry does not help improve health outcomes or reduce the burden of employee furloughs on societal balance sheets. Universal owners (meaning large pension funds) do not want human capital to be a competitive factor, but they do want standards to rise across society. Similarly, oil companies must cooperate with one another and with governments to meaningfully introduce alternatives and reduce dependence. This co-operative activity will overwhelm the relative ESG analysis of company operations, since the differences in operational emissions pale in comparison to credit risks associated with systemic demand declines.
Sustainability themes will continue to provide a strong lens –
In today’s crisis, government is prioritizing industries that it deems essential. Ironically, this trend is entirely congruent with the rise of “impact” investing. As today’s focus on data quality, disclosure and corporate structure standardizes by market cap and sector, emphasis will shift to the purpose of the company itself. After all, manufacturing ventilators or discovering vaccines is not the same as making products that increase respiratory risk, such as tobacco or combustion pollution; from an impact perspective, that the cost of capital for one should be lower than the other is aligned with societal objectives towards resiliency and health and well-being. Applying a thematic lens can capture these long-term trends while steering through shorter-term cycles and can provide a more predictable basis for outperformance.
Just as every bear market and recession provides the inevitability of recovery, the current crisis may be an appropriate end to ESG 1.0 and a beginning for ESG 2.0. We are hopeful that ESG 2.0 can build on the successes of the last 20 years, while contributing meaningfully to a market philosophy that rewards shareholders but equally emphasizes the importance on government and workers. Our common future may depend on it.
Martin Grosskopf is a Vice-President and Portfolio Manager at AGF Investments Inc, he manages AGF’s sustainable investing strategies and provides input on sustainability and environmental, social and governance (ESG) issues across the AGF investment teams. He is a thought leader and a frequent public speaker on ESG and Green Finance issues. Martin has more than 20 years of experience in financial and environmental analysis. He manages the AGF Global Sustainable Growth Fund which is available through the AGF Global Sustainable Growth ETF (AGSG). He is a regular contributor to AGF Perspectives.
References:
i https://www.wbcsd.org/Overview/News-Insights/Insights-from-the-President/The-triangle-that-will-fix-capitalism
ii https://www.amazon.ca/Models-Behaving-Badly-Confusing-Illusion-Reality-Disaster/dp/1439164991
iii https://www.fsb.org/
The commentaries contained herein are provided as a general source of information based on information available as of June 18, 2020 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
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