Multi-asset managers shared their views on effective diversification for investors facing difficult market conditions as inflation soars to 40-year highs, while they also suggested new products they would like to see in the ETF space to meet their needs in the current climate.
Taking part in an Investment Week roundtable discussion in association with State Street Global Advisors on 16 June on sector and factor investing, the panel discussed the issues for investors of having high exposure to a handful of mega-cap tech stocks and the impact of the rotation from growth to value.
Tim Edwards, managing director and global head of index investment strategy at S&P Dow Jones Indices, explained: “If you take a passive [US] exposure, you have roughly 25% of your exposure to five stocks. Meanwhile, the S&P 500 Growth index is 40% in five stocks, which is one reason why 99% of US growth managers underperformed this index last year. That has very much started to turn, and so it is hard to be a stock picker and hard to do broad-based market investing, but what can you do?
“I think this notion of diversification is important, when you have got so much technology at the top of the market, and it does prejudice thoughts around the question of what should I barbell this with? We have mentioned energy and SPDR’s low volatility fund has seen quite a lot of interest recently, and this is another nice way to think about de-risking, which is the goal of diversification. It is an important topic, to which different viable solutions exist, making it more interesting.”
Fahad Hassan, CIO at Albemarle Street Partners, observed: “The interesting thing is we have been through a momentum crash on growth. You can get a momentum crash on low-volatility as well or on value, depending on which stage of the cycle you are. These momentum crashes either happen because there are some financial valuation issues, or underlying business problems.
“While it is good to do well and have lots of inflows on low-volatility funds, that will change on a dime if the Fed calls it a day or something, because all those flows will come out, and then those stocks become sources of cash, and everything else is more attractive. It is quite interesting to have that momentum lens on.”
Vipul Faujdar, SPDR’s ETF UK sales specialist and SPDR head of smart beta sales EMEA, highlighted SPDR’s sector rotation model, in partnership with Relative Rotation Graphs (RRG), which is focused on sector outperformance and the momentum of that outperformance.
“It really shows those early indicator signs from a momentum perspective of where the sectors are going,” he said. “Technology, communication services and consumer discretionary are still in that quadrant where they are weak, but they are starting to show improvement.”
The panel also discussed overweight positions in the energy and mining sector and whether flows will continue to remain strong in this area.
Albemarle’s Fahad Hassan said: “I think that money is still pouring in. One of the good things about energy here is that you still have the second order effects, where you have [companies] de-risking balance sheets. They are not going out and spending on capex. They will start paying you those dividends. You can start de‑risking by collecting coupons or dividends. I think that is a story yet to play out in energy, because I think they have not yet increased dividends to the extent they can. You will quickly find out that they do not have many uses for cash because ESG prevents them.”
S&P Dow Jones Indices’ Edwards responded: “There is the elephant in the room. Energy’s performance has been fantastic, and performance does attract capital. However, compared to a normal market cycle, the conversations my company is having with institutions in Europe and in the US are all about ESG right now. Traditional fossil fuel investments are not top of the list.”
Meanwhile, the panel also discussed the drivers behind the majority of the markets inflows into the factor space this year going into dividend strategies, of which around a third have been into the SPDR Dividend Aristocrats ETF series, composed of stocks that have increased or maintained dividends over a consistent period. An ESG version of Dividend Aristocrats has now been available for a year in Europe.
Tim Edwards said in his view the level of inflows into this space is partly attributable to inflation pass-throughs, as well as the simplicity of the index’s construction.
“There are lots of different ways that you can try to identify those companies who would be able to pass through inflationary costs to investors and maintain their margins. [Companies] able to increase dividends year after year for 20 years are good potential candidates for inflation pass-throughs.
“I also really like the index construction as it is not overly sophisticated. It is companies that have increased their dividends for 20 years and they get kicked out if they cut or suspend the dividend. Globally, a lot of the interest in the series has come from the wealth market.”
Joe Aylott, associate director at Coutts, commented: “We have been considering dividend strategies, and given what is happening in fixed income markets at the moment, one way of thinking about dividends is that they are in some ways an inflation-protected yield, because obviously earnings are nominal.
“Even though the Aristocrats are slightly different in the sense that they are growing, but even if they are not, if nominal earnings are growing and your pay-out ratios are the same, you can consider dividends to just be a way to access yield that is inflation protected. That is one reason perhaps that is feeding into why it looks so attractive now, or why it is seeing a lot of flows at the moment.”
Finally, the panel gave their suggestions for new ETF products they would like to see to provide exposure to certain areas and add further diversification to portfolios.
Salim Jaffar, investment analyst at Seven Investment Management, said: “We are looking for a specific metals and mining ETF. VanEck have a product, but the problem we found was that 30% revenue-wise is exposed to gold. That is a very different exposure to either transition metals or steel. That was something we were looking for and could not really find. There is a BlackRock investment trust, but it is extremely expensive, and has different volatility characteristics and liquidity, on account of being an investment trust.
“Another ETF that we were thinking about, that is interesting given this discussion, is vol-selling ETFs. Our view is, following the sell-off, we think the S&P is going to be relatively range-bound, but you will still have elevated volatility. We have structured notes for put selling, but in an ETF wrapper it is easier than dealing with a structured note, and you also cannot use structured notes for model portfolios.”
Albemarle’s Hassan added: “I do not know whether you can do ESG value, but there are people talking about it. An ESG low volatility product would be ideal because it gives you that offset versus technology because you already have a growth bias.”
This post was funded by State Street Global Advisors