Pandemic or not, foreign equities remain a core asset class. Within the Canadian ETF universe, the broadest geographic exposure is through the more than 50 funds in the global equity category.
Despite their similarities — all have holdings in the United States and the developed markets of Europe and Asia —they’re a diverse group. From passive market-cap-based indexing, the selection has expanded into factor-based or income-focused strategies, and a few that are fully actively managed.
Assuming that clients want foreign exposure through one or more equity ETFs, how can advisors recommend suitable picks?
As a starting point, consider a broad index exposure, says Scott Johnston, head of product for Toronto-based Vanguard Canada Investments Inc.
Examples of these types of market-cap based funds include Vanguard FTSE Global All Cap ex Canada Index ETF and iShares MSCI World Index ETF. Of the two, Vanguard’s is the more comprehensive — and somewhat more growth-oriented — because it includes emerging markets. Its iShares rival, which was the ETF pioneer in the global category when launched in 2009, invests only in developed markets and has a 3% weight in Canadian stocks.
Mark Raes, managing director and head of product with Toronto-based BMO Global Asset Management, agrees that while broad market exposure is one solution, investors may want their global holdings to have a different risk profile. “You might want a low volatility or a quality exposure. But if you’re more generally constructive on markets, you might just want market cap,” he says.
For any investor, determining the right mix of asset classes is crucial. Within the portion devoted to global equities, ETFs that employ minimum-volatility strategies are well suited for conservative investors.
According to Toronto-based BlackRock Asset Management Canada Ltd., iShares Edge MSCI Min Vol Global Index ETF had a beta at the end of April of 0.61 over the past 36 months and 0.58 over the past 60 months, when measured against its benchmark MSCI World Index (by definition, the broad market has a beta of 1).
“The underlying theory is that you can reduce the volatility of the portfolio, smooth out the ride, while maintaining the same overall expected equity returns,” says Steven Leong, head of ETF product with BlackRock Canada. “You have less sensitivity to the broader market, both on the way up and on the way down, but more sensitivity on the way up than on the way down.”
The iShares low-volatility ETF is extremely diversified, with exposure to about 450 holdings. Vanguard Global Minimum Volatility ETF, by comparison, has a still-hefty 230 holdings, and a similarly low beta of 0.77 at last report.
Though advisors should look at many criteria, says Johnston, beta is a useful tool to help establish which funds are more conservative or aggressive.
Among the least risky in the global equity category is BMO Global High Dividend Covered Call ETF, which holds dividend-paying common stocks while writing call options on selected holdings. But this strategy has much reduced scope for capital growth. The covered-call ETF monetizes “excess upside” by selling call options in exchange for premium income, says Raes, so it’s not a pure equity exposure.
For a factor-driven strategy with more growth potential, consider ETFs based on quality metrics such as return on equity, earnings growth and balance-sheet strength. “Quality is a factor that really plays well across market cycles. You’re certainly seeing that now,” says Raes, referring to the recent above-average performance of BMO MSCI All Country World High Quality Index ETF. The ETF returned 0.8% in the first four months of this year, versus a 9.1% loss for the median global equity fund, according to Morningstar Canada.
Raes adds that a fund with a socially responsible mandate also has a quality tilt because of its emphasis on corporate governance and sustainability. Screening for environmental, social and governance criteria “helps to identify companies that really have a long runway in front of them.”
Global dividend strategies, meanwhile, are suitable for investors looking to generate regular income. But don’t expect funds like iShares Core MSCI Global Quality Dividend Index ETF to be less risky than the broad market, says BlackRock’s Leong. “You don’t have an explicit focus on lowering the risk of the portfolio. You’re just more oriented towards the dividend payment.”
Though most global equity ETFs are fully exposed to fluctuations in foreign-exchange rates, there are currency-hedged alternatives. But Leong cautions that it’s “notoriously difficult” to forecast currency movements accurately. Besides, since the Canadian dollar tends to be correlated positively with equities, “holding your international exposure in non-hedged form tends to act as a diversifier.”
Fully active global strategies present opportunities to outperform the market through more concentrated portfolios and individual stock selection. Dynamic Active Global Dividend ETF is one of two in the category that has the top five-star Morningstar Rating for risk-adjusted returns. The other is BMO’s high-quality ETF.
Depending on an investor’s risk tolerance, a “core and satellite” approach can be taken by holding a pair of global ETFs. Starting with a core index exposure, the portfolio could be tilted in a conservative direction by also holding a minimum-volatility product. Conversely, an index ETF could be combined with a factor-based or fully active strategy. “Any decision you take to seek to outperform the broad market is higher risk,” says Johnston. “You’re actually taking on active risk. The way we think about it is how strongly you make that active decision.”
By pairing a passive ETF with an actively managed fund, you can get the best of both worlds, says Raes. “You get the opportunity for alpha and outperformance from the active manager, but you get the discipline and the market exposure from the passive ETF. We’re seeing a lot of interest that way from advisors.”