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Finding Flexibility When Markets are Fickle

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With market uncertainty expected to persist through the year, an explicitly targeted portfolio may help stave off the stress.

If you ask investors what type of stocks they would like to invest in, chances are they would answer that they want cheap stocks that have sound businesses and potential for significant returns. Beyond common sense, over 50 years of research supports this view: that inexpensive stocks tend to outperform more expensive stocks (value); healthy companies tend to outperform less healthy companies (quality); and lower volatility stocks tend to generate a higher risk-adjusted return than high volatility stocks.

In today’s environment of heightened market uncertainty, this combination of characteristics may just be the kind of stock mix your portfolio needs — offering both defensive and growth potential.

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However, the prospect of sifting through hundreds of companies to screen for value, quality and low volatility (referred to as factors) can be daunting, even for investment professionals. If you had the advantage of utilising an index that targets all three factors and that gives you broad exposure beyond the Australian market, the opportunity would be within easier reach.

 

Time in the Market

The MSCI World Factor Mix A-Series Index, for example, captures 1,652 large-and mid-cap stocks across 23 developed countries[1] and aims to represent the performance of value, low volatility, and quality factor strategies in one index. (This approach of tilting a portfolio to one or more factors is called smart beta.)  An exchange traded fund (ETF) tracking this blended index creates an equity portfolio with low volatility equity exposure with an equal focus on high quality and attractively valued firms.

The key benefit for investors of combining value, quality and low volatility is the flexibility to adapt to different market environments. Investors sometimes focus on “timing” the market when conditions change, but given the unpredictably of market-impacting events (of late, Brexit and the Trump presidency) investors may find it opportune to think more about their “time in the market”, focusing on the long term.

A diversified portfolio targeting the above factors aims to deliver a smoother return pattern for investors over time: the low volatility factor aims to enhance downside risk protection during downturns (losing less), while the quality and value are aimed at potentially increasing returns by targeting firms with quality balance sheets and stable profitability at inexpensive valuations. The three-factor approach also helps offset the impact of economic cycles. Low volatility and quality tend to do very well in tougher market environments, but not as well during market upturns. Value, on the other hand, tends to be sensitive to market distress and macro shocks. In a way, investors are getting three benefits from a single investment.

 

Easy Implementation

Until recently, finding an investment vehicle in the local market for a strategy that seeks to capture multiple factors had been impossible. But with the introduction of smart beta ETFs, investors now have easy access to sophisticated portfolio-tilting strategies that were previously available only to institutional investors. Traded on the ASX like ordinary shares, these ETFs (which include the SPDR® MSCI World Quality Mix Fund) offer trading flexibility and cost-efficient implementation. Globally, smart beta ETFs reached nearly US$500 billion in assets under management as of November 2016, up 18% from the beginning of the year[2], underscoring growing investor interest in this investment approach.

Investing in a global ETF instantly expands the opportunity set and enhances the diversity of stock selection. A global index targeting all three factors may be able to create a portfolio of nearly 500 stocks.

Finally, when comparing ETFs, investors should be aware the index methodologies vary. The screening rules applied by the MSCI World Factor Mix A-Series Index aims to select only stocks that pass robust metrics. To find value stocks, stocks are ranked based on fundamental accounting data—sales, book value, earnings and cash earnings—rather than market prices. For quality, they are ranked based on high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. This means the resulting portfolio avoids heavily indebted companies and cash flow-challenged firms, which may also exhibit low valuations, for example. Not all indices are created equal, and methodologies could play an important role in the fund’s ultimate performance.

 

MSCI World Factor Mix A-Series Index Performance

 

                ANNUALISED
  AS OF MONTH END 1 MONTH 3 MONTH YTD 1 YEAR 3 YEAR 5 YEAR SINCE INCEPTION 11-SEP-2015
                 
Index 31-Jan-2017 -2.54% 5.35% -2.54% 8.51% N/A N/A 5.38%

Source: SSGA as at 31 Jan 2017

Performance quoted represents past performance, which is not a reliable indicator of future results. Performance returns for periods of less than one year are not annualised. Current performance may be higher or lower than that quoted. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.

 

Learn more about SPDR® MSCI World Quality Mix Fund (QMIX).

 

Issued by State Street Global Advisors, Australia Services Limited (AFSL Number 274900, ABN 16 108 671 441) ("SSGA, ASL") www.ssga.com.This material is of a general nature only and does not constitute personal advice. It does not constitute investment advice and it should not be relied on as such. It does not take into account any investor's objectives, financial situation or needs and you should consider whether it is appropriate for you. You should consult your tax and financial adviser.© 2016 State Street Corporation —All Rights Reserved. AUSMKT -3327 | Expiry date: 30 May 2017.

 

 

[1] Source: MSCI, as of 30 January 2017.

[2] ETFGI, http://etfgi.com/news/index/newsid/1549

 

Finding Flexibility When Markets are Fickle
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