24 Mar 2017 - Hedge Clippings

ETF's are only cheap (good value) in a rising market

One of the great financial product success stories of the past few years has been the dramatic increase of flows into ETF's, which not surprisingly, have had a significant effect on the rise and rise of the overall market.

Based on the concept of a rising tide lifts all ships, ETF's have assisted those tidal flows, as investors, no doubt encouraged by the manufacturers and marketers of ETF's, have sought a simple and low-cost approach to gaining equity market exposure. As investors' funds flow in, by definition they find a home across all stocks in the index according to their weight, and which naturally helps support and/or lift the market.

In turn, the rising market helps the marketers sell the benefits of their products to more and more investors, who are encouraged not only by the performance but the low fee structure. And so it goes on.

Or at least it will until there is a market correction, and - however buoyant the market may seem - there will be one eventually.

When this does occur there is a danger that the rising tide effect of ETF's reverses, and becomes a falling tide. As investors, concerned about capital losses, redeem from ETF's, it will in turn create downward selling pressure on the market, which in turn well result in more investors redeeming or withdrawing. And so it will go on.

Hedge Clippings is not against ETF's as such, and many smart investors use them to gain low-cost exposure to equity markets. However, many other investors ignore the fact that a simple index ETF employs no risk process in the event of a falling market, and therefore they offer no downside protection.

This is relevant at the current stage in the cycle, as markets continue to rise (in spite of a minor bump in the past week), so it is worth looking at recent comments in February investor newsletters from some well-respected active equity managers.

For instance, Richard Fish of Bennelong Long Short Equity, (who has returned an average of 16.5% per annum over the past 15 years) noted:

"The US S&P 500 index has rallied almost 15% since Trump's election victory in early November. Accordingly the forward P/E multiple of the S&P 500 is now over 18 times (its highest level since the unwind of the early 2000's tech bubble) and the relative strength index (a momentum indicator) has moved into the mid-70s (historically a sign that the market is overbought). It's as though the issues plaguing markets 12 months ago, such as China's growth challenges, US policy rate normalisation, European fiscal reform, no longer exist. Yet such issues have far from disappeared."

Meanwhile, George Colman from Optimal Australia (one of the most risk averse funds in AFM's database) wrote:

"Our strategy often underperforms a broader market when it rallies strongly, as we favour downside investor protection when we see many stock prices move well above fundamental fair value. We believe we are at such a junction at present and we continue to worry about downside risk."

And as Mike Surridge from KIS Capital (annual returns of 14.67% pa over 7 years and a Sharpe Ratio of 2 since inception) observed this week when discussing the forward P/E multiples of many stocks now over 20 "At these high levels many investors and brokers don't like to memntion these high P/E multiples as it makes the stock look expensive. They're much happier talking about a yield of 5% which given current cash rates, makes them look cheap."

ETF's may be cheap, but the old adage that you only get what you pay for is often worth remembering.

PERFORMANCE NEWS

Affluence Investment Fund increased 1.20% in February, resulting in a +13.41% return for the latest 12 months. Since inception in November 2014, the Fund has an annualised return of 9.98% p.a.

Pengana Absolute Return Asia Pacific Fund returned -0.04% for the month of February 2017, compared to Asia Pacific markets which posted a gain of 2.4%. The Fund has an annualised return since inception of 8.49% p.a.

Collins St Value Fund rose 0.46% for the month of February, taking the latest 12 months return to 23.85%.

Pengana Global Small Companies Fund was up 0.8% for the month of February, compared to a 1.1% return for the MSCI AC World SMID Cap Index. Over the past 12 months, the Fund has returned +16.45%, taking the annualised return since inception to 5.57% p.a.

Bennelong Australian Equities Fund gained 1.58% in February, taking the Fund's one year return to 11.87%. Since inception, the Fund's has an annualised return of 13.27% p.a.

Touchstone Index Unaware Fund returned +3.16% in February, outperforming the ASX 200 Accumulation Index 2.25%, by +0.91. The Fund has gained +7.80% over the latest 6 months.

Pengana PanAgora Absolute Return Global Equities Fund returned +0.87% in February, taking the annualised return since inception to 10.15% p.a.

FUND REVIEWS released this week: Bennelong Twenty20 Australian Equities Fund; Optimal Australia Absolute Trust; APN Asian REIT Fund;

And on that note, have a great weekend. 

Regards,

Chris
CEO, AUSTRALIAN FUND MONITORS

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Australian Fund Monitors are helping to raise awareness to support research into prevention and cure for cerebral palsy. For more information visit www.cpresearch.org.au or contact me by email.