Best and worst ETF asset classes

March 30, 2020

Financial and commodity markets continue their high-volatility gyrations as the effects of the coronavirus pandemic bring global economic growth to a virtual standstill. As investors become more pessimistic, the instinctive “flight to safety” during economic downturns takes root.

Paradoxically, the fourth week of March turned quite bullish, as the Dow Jones Industrial Average posted its best single day since 1933. Other major indices, such as the S&P 500 Composite, the S&P/TSX Composite, and the Nasdaq Composite have also rallied from their lows reached around March 23. While most of the carnage occurred in March, we will analyze the early onset of this downturn at the end of February. We will re-examine asset allocation changes in our mid-April report.

Three-year and five-year maximum drawdowns for most funds in the U.S. Equity, Canadian Equity, and Global Equity categories will change by the time our first-quarter Currency & Sector Liquidity Analysis Report is published in April, as equity markets have suffered their worst declines since the 2008-09 financial crisis.

Much of the discussion in the investment community currently concerns the resiliency of the ETF industry, which carries such enormous weight in global markets. It is important to analyze the performance of these investment vehicles, because inflows can theoretically stay persistent and increase at a growing rate, but what’s the point if the underlying fund is underperforming?

Chart 1 breaks down the more detailed category returns for the Canadian ETF market. The study included 842 Canadian ETFs, excluding daily reset and inverse funds.

The equity category has been hit hardest, with 547 decliners and seven gainers in February. The commodity space has faced stiffer headwinds, particularly for the energy sector, with Commodity-based ETFs posting 15 decliners and three gainers in February. Alternative ETFs showed some stronger returns relative to the other groups, with 10 decliners and five gainers. This may give liquid alternatives a strong selling point appealing to those investors looking to allocate a small portion of their portfolios to this new asset class.

Fixed income has been the poster child in these trying times, as most investors are moving to low-risk debt instruments. Among fixed-income ETFs, 88 declined while 132 posted positive returns. In the Balanced category, 24 declined while only one positive a posted return, as their equity bias dampened values.

Cash held by investment funds is on the rise, and the new class of cash-deposit and high-interest savings ETFs enjoy inflows. In this high-level class, two ETFs posted negative returns, while eight posted positive returns.

Table 1 drills deeper into the asset classes to analyze which ETF investment mandates are weathering this storm efficiently. The analysis includes 842 Canadian ETFs.

Again, we want to look at this from a total portfolio approach, and not cherry-pick a single ETF as an example of generally astounding returns. The percentage of ETFs that posted positive returns in that specific asset class is shown in the second column from the left.

While many investors may have a significant portion of their holdings in Equity categories, it is important to diversify portfolios in these trying times to include some cash and more importantly, fixed-income strategies. We can see that Liquid Alternative funds with a hedge strategy are earning a name for themselves by keeping volatility low.

The sectors that are now seeing the best returns are Government Bond and Money Market ETFs, which have produced the best positive monthly returns during February (Chart 1). Broad-market fixed income and corporate fixed income have also demonstrated resilience during the market rout.

The U.S. Federal Reserve Board, the Bank of Canada, and central banks all around the world continue to pump liquidity into the market by means of quantitative easing, a monetary policy tool used to purchase bonds and mortgage securities. In addition, unprecedented fiscal policy has also been adopted by governments around the world in an effort to cushion the worst of the economic slowdown and build a base for recovery once the pandemic as passed.

For investors, especially equity investors who have cash reserves, it is imperative not to try to call a bottom in this market. During the current period of extreme volatility, it is easy to be whipsawed as the market appears to take a step forward but then immediately takes two steps back. The best investors maintain diversified holdings and keep their powder dry for use in deeply-oversold opportunities that will appear in due course.

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