HollisWealth’s Denise Davids recommends low-volatility and U.S. consumer staples sector ETFs.
Wild stock-market gyrations can be nerve-racking for investors, but there are defensive strategies that can help ease the pain.
Exchange-traded funds (ETFs), which are baskets of securities that trade like stocks, can offer some downside protection through diversification. But many also have other features that can mitigate risk. Investors can own so-called "low volatility" ETFs which track stocks that tend to hold up better in down markets. There are ETFs focused on defensive sectors, such as utilities or consumer staples that tend to have more stable earnings regardless of the economic cycle. And there are income-oriented offerings such as dividend-growth and bond ETFs, which can also help reduce red ink during choppy markets.
We asked three experts for their top defensive ETF picks.
Daniel Straus, ETF analyst at National Bank Financial Inc., Toronto
Fund: BMO Low Volatility U.S. Equity Hedged to CAD ETF (ZLH-TSX)
Management expense ratio (MER): 0.34 per cent
This ETF is the currency-hedged version of BMO Low Volatility U.S. Equity ETF (ZLU-TSX), which "proved its mettle" during market turmoil this year, says Mr. Straus. When the S&P 500 tumbled about 10 per cent (in U.S. dollar terms) from the start of this year to Feb. 11, the unhedged ETF fell by two percentage points because of an overweight in less-volatile utility and financial stocks. The ETF tracks 100 U.S. large-cap stocks. Rising interest rates, however, could hurt returns if investors flee stocks of utilities and dividend payers in favour of higher-yielding bonds, he said. The hedged ETF is a better bet if the loonie rises versus the U.S. dollar, while the unhedged ETF benefits from a stronger U.S. greenback.
Fund: Vanguard Utilities ETF (VPU-NYSE)
MER: 0.10 per cent
This ETF, which is the cheapest among its U.S. utility peers, is among the "safer havens during market downturns," says Mr. Straus. The sector is less affected by a collapse in crude oil prices or other global shocks because utility companies have more dependable cash flows stemming from long-term contracts, he said. During wild market swings, the healthy dividends offered by these companies tend to keep investors loyal, he added. This ETF, which tracks 82 stocks, holds names like NextEra Energy Inc., Duke Energy Corp. and Southern Co. A sudden rise in interest rates is a risk for utility ETFs if their fixed payouts become less appealing versus newly issued, higher-yielding bonds, he noted.
Denise Davids, ETF analyst at HollisWealth Inc., Toronto
Fund: BMO Low Volatility Canadian ETF (ZLB-TSX)
MER: 0.40 per cent
Because this ETF tracks only about 40 Canadian low-volatility stocks, it looks "substantially different from the underlying equity market," says Ms. Davids. The ETF holds stocks in defensive sectors, but there are "no clear sector bets so investors aren't putting all of their eggs in one basket," she added. The fund is 32 per cent invested in financials, 17 per cent in consumer staples and 12 per cent in utility stocks. Top holdings include Fairfax Financial Holdings Ltd., Canadian Real Estate Investment Trust and Dollarama Inc. When investing in this kind of ETF, the trade-off is that investors could lose some of the upside potential from a strong-performing stock market, she said.
Fund: Consumer Staples Select Sector SPDR ETF (XLP-NYSE)
MER: 0.14 per cent
This popular ETF is a "very affordable" way to get exposure to the U.S. consumer staples sector, says Ms. Davids. "It holds mostly well-known defensive companies that have a distinct competitive advantage." The ETF tracks 39 large-cap companies. It is about 24 per cent invested in food-and-staples retailing, 21 per cent in beverage firms and 18 per cent in food products. Top holdings include names such as Procter & Gamble Co., Coca-Cola Co., Philip Morris International Inc., PepsiCo Inc. and Wal-Mart Stores Inc. The sector's healthy dividends have attracted investors looking for yield in an ultra-low interest rate environment, but rising rates could cause them to look elsewhere for yield.
Christopher Davis, director of manager research at Morningstar Canada, Toronto
Fund: Vanguard U.S. Dividend Appreciation ETF (VGG-TSX)
MER: 0.27 per cent
This ETF, which tracks U.S. companies with a record of rising dividends, has "a collection of the highest-quality companies that you could purchase," says Mr. Davis. One quarter of the 178-stock portfolio is invested in the defensive consumer sector, he noted. Top holdings include Microsoft Corp., Johnson & Johnson, Coca-Cola and Procter & Gamble. During the 2008 stock market crash, the S&P 500 index tumbled 37 per cent (in U.S. dollar terms), while the U.S.-listed version of this ETF (VIG-NYSE) lost 26 per cent. "The ETF is not going to give you miracles, but it does provide your portfolio a defensive tilt while … still offering the possibility of reasonable gains in up markets," he said.
Fund: Vanguard Canadian Aggregate Bond ETF (VAB-TSX)
MER: 0.14 per cent
This ETF, which tracks a Canadian bond index, can help lower the risk because 70 per cent of the fund is in government bonds, says Mr. Davis. The ETF has a minuscule yield so return prospects are limited relative to stocks and the yield is low relative to what bonds have done over the past 30 years, he acknowledged. For investors who have an aversion to volatility and a short time frame before needing the money, it does make sense to hold part of a portfolio in bonds, he said. This ETF could suffer when bond prices fall in a rapidly rising interest rate environment, but "it's a fool's game" to forecast rates, he said. In 2014, many predicted interest rates would rise, but in fact they fell.