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Active role for Exchange Traded Funds

Active role for Exchange Traded Funds

By Tony Featherstone 10.12.2018


Exchange Traded Funds (ETFs) are usually promoted as long-term, passive tools. Investors hold ETFs in their portfolio core for many years to achieve the index return at low cost. 

Less considered is the role of ETFs as tactical investments. That is, using them to profit from short-term market moves, such as a possible New Year sharemarket rally in Australia.

The term “passive” in ETFs is misleading as it implies investors are not engaged in the process. The act of buying an ETF is in itself “active” and some people use ETFs in highly active strategies to profit from market rallies and falls in a form of active trading management. 

Long-term portfolio investors who want to enhance returns can also use ETFs in active strategies. I’m not suggesting they start day-trading or bet recklessly. Rather, that active investors take considered positions to profit from short-term market moves. 

Consider a portfolio investor who believes the Australian sharemarket will rally in the next 12 months, possibly towards the previous S&P/ASX 200 high of 6,352 points in August 2018. If that view is correct, the investor would achieve a 10 per cent return, more after dividends.

From a technical perspective, holding support above 5,600 points during the October sell-off was a healthy sign for our market. It suggests investors believe the market is oversold at that level and are willing to buy shares and drive it higher.

Our market sell-off was more about global factors than local ones. The market was spooked by the tech sell-off, trade-war fears, slowing Chinese growth and geopolitical concerns. After soaring gains in the US tech sector, investors took profits on the first sign of bad news.
 
I cannot see the sell-off in Australian stocks morphing into a grizzly bear market. More likely is a “gummy” bear market because savage corrections usually occur when recession risks rise. For now, our economy is a long way from recession, even after this week’s softer GDP figures. 

Don’t get me wrong: I’m not overly bullish on our market in the medium term (1-3 years). I still expect a long, slow grinding recovery in Australian equities as the market edges higher each year.

Lower-than-usual equity returns, over a long period, strengthen the case to take a more active approach to portfolios. 

This strategy does not suit conservative or inexperienced investors and those that use it must consider position sizing – the proportion of funds allocated to the idea – and have a stop-loss level (a pre-determined point to sell, to preserve capital). 

Caveats aside, if you believe the market will rally into the New Year, an ETF over the S&P/ASX 200 index makes sense. There are several options and State Street’s S&P ASX 200 Fund (ASX Code: STW) is the largest and best known, though not the cheapest.

The ETF is designed to provide the same price and yield return as the ASX 200, before fees and other costs (such as brokerage). STW’s fee is 19 basis points. 

Chart 1: SPDR 200 Fund 
Source: The Bull 

More aggressive investors could consider the BetaShares Gear Australian Equity Fund (GEAR). The ASX-quoted hedge fund is internally geared, meaning it provides leveraged exposure to the ASX 200 index. The fund’s gearing ratio is about 50-65 per cent. 

Like other geared products, the fund magnifies gains and losses. A 10 per cent return from the ASX 200 would be considerably higher with GEAR because it combines investors’ funds with borrowed funds to invest over the ASX 200. 

Unlike margin loans, there are no margin calls (that require investors to restore the gearing ratio) and fees are relatively low at 80 basis points for a geared product of this kind.

Always take extra care with geared products. As mentioned, gearing amplifies losses as well as gains. A 10 per cent fall in the ASX 200 would be more for an investor using GEAR. 

Also, many ASX 200 companies are highly geared as it is, meaning investors are borrowing to buy companies that already have lots of borrowing. This is not a strategy for risk-averse investors. 

GEAR lost 6 cent in October, BetaShares data shows and is down 23 per cnet over three months. GEAR fell 2.2 per cent in a trading day earlier this week when the market sold off. 

However, if you have a high conviction that the Australian sharemarket has fallen too far, and that it can make back some gains January or February, GEAR is a low-cost option to back that view and magnify exposure. Provided investors understand the extra risks in gearing.

Chart 2: BetaShares Gear Australian Equity Fund
Source: The Bull

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week's newsletter

 

• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at December 6, 2018.



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