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Cameco stock is a top holding in an energy-transition ETF that could be a satellite play within a retirement savings portfolio, one analyst says. THE CANADIAN PRESS/Liam RichardsLiam Richards/The Canadian Press

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When building a retirement nest egg, a core-satellite strategy can enhance diversification and the potential for higher returns.

For investors who use exchange-traded funds (ETFs), the core of a portfolio should be in cheap, passive ETFs tracking major indexes such as the S&P/TSX Composite Index or the S&P 500. But a smaller portion, such as 10 per cent of a portfolio, can be allotted to so-called “satellite ETFs” that focus on long-term themes or sectors, such as industries or countries. Their fees are typically higher than plain-vanilla ETFs, especially in the case of actively managed funds.

Globe Advisor asked three ETF experts to give their top satellite picks for a registered retirement savings plan (RRSP).

Daniel Straus, managing director of ETFs and financial products research, National Bank of Canada Financial Markets, Toronto

The pick: iShares S&P/TSX Energy Transition Materials Index ETF XETM-T

Management expense ratio (MER): Not available yet, but the management fee is 0.55 per cent

This ETF is a compelling thematic play because it owns miners of commodities that will play a big role in the energy transition to renewable resources, Mr. Straus says.

The fund tracks an index of firms producing materials, such as copper, lithium, silver, platinum, and uranium. Cameco Corp. CCO-T, Freeport-McMoran Inc. FCX-N and Albemarle Corp. ALB-N are top holdings.

Because investing in resources stocks can be a hedge against rising prices, this ETF could also provide some inflation protection, he adds.

National Bank economists and strategists believe there are forces in the global economy, such as de-globalization that could mean relying less on cheap labour, that could make inflation persistent, he notes.

This ETF, which launched last September, has an “operational risk” in that it could be delisted if there’s insufficient interest, he says. The management fee, he adds, is reasonable for a thematic ETF.

The pick: Tema American Reshoring ETF RSHO-N

MER: Not available yet, but the management fee is 0.75 per cent

This ETF, which invests in companies that can benefit from bringing manufacturing back to the U.S., can be a good diversifier to broad-based index funds within a portfolio, Mr. Straus says.

This reshoring theme also coincides with the views of National Bank economists and strategists who believe that U.S. and European companies have “gone overboard” with hyperglobalization, he says.

Supply-chain disruptions were common during the COVID-19 pandemic, but that has also been the case recently with attacks on shipping in the Red Sea by the Yemen-based Houthi militia group.

Top holdings in this ETF include Rockwell Automation Inc. ROK-N, Caterpillar Inc. CAT-N and Vulcan Materials Co. VMC-N.

A risk for this ETF, which holds about 30 names, is that it is actively managed, so its performance depends on picking the right stocks, he says. This fund, which launched last May, has a high 0.75-per cent-management fee, but that could come down if it achieves scale, he says.

David Kletz, lead portfolio manager, Forstrong Global Asset Management Inc., Toronto

The pick: WisdomTree Japan SmallCap Dividend Fund DFJ-A

MER: 0.58 per cent

This ETF, which focuses on smaller Japanese companies, is compelling because it’s 25 per cent invested in export-oriented, industrial companies that should benefit substantially from an undervalued yen, Mr. Kletz says.

Japan is also the only major market that has not tightened monetary policy, he adds. The central bank has kept its interest rate at minus 0.1 per cent, so there’s potentially “considerable currency upside.”

Historically, “when the yen goes up, stocks go down,” he says. “Why that does not particularly bother me this time is how cheap the yen has become.”

Japanese equities, in local currency terms, had a good year in 2023, but valuations are still not as pricey as the U.S. market, he notes. The ETF also has more than 700 dividend-paying stocks, “so there is a bit of a value-tilt to the portfolio.”

Risks include a rising yen weighing on stocks, while Japan’s low birth rate and aging population could hurt economic growth, he says.

The ETF’s 0.58-per-cent MER is steep, but competitive with similar types of funds, he adds.

The pick: KraneShares CSI China Internet ETF KWEB-A

MER: 0.69 per cent

This ETF, which has been hit hard because of China’s regulatory crackdown on the technology sector, now “represents a good, long-term entry point into a solid growth opportunity,” Mr. Kletz says.

The ETF holds Chinese internet companies, such as Alibaba Group Holding Ltd. BABA-N, PDD Holdings Inc. PDD-Q and Tencent Holdings Ltd. TCEHY-OTC.

“The regulatory firestorm has definitely cooled off,” he says. “These are companies with significant revenue, which have positive revenue growth potential with their focus on a burgeoning middle class.”

China’s economy is showing signs of recovery after a disappointing 2023, so companies in the internet sector stand to benefit from having its focus on the domestic consumer, he adds.

There is still a risk from more government regulation, but that’s why valuations are attractive, he says. “Convincing investors to re-engage with Chinese assets may also be a bit of an uphill battle.”

The MER is not cheap at 0.69 per cent, but ETFs focused on an emerging-markets niche tend to come with a higher price tag, he says.

John Hood, portfolio manager, Croft Financial Group Inc., Pickering, Ont.

The pick: Invesco S&P MidCap Quality Index ETF XMHQ-A

MER: 0.33 per cent

This ETF, which invests in U.S. mid-cap stocks, is a value play and can help diversify away from the S&P 500, which has been dominated by the “magnificent seven” stocks, Mr. Hood says.

The seven include Alphabet Inc. GOOGL-Q, Amazon.com Inc. AMZN-Q, Apple Inc. AAPL-Q, Meta Platforms Inc. META-Q, Microsoft Corp. MSFT-Q, Nvidia Corp. NVDA-Q, and Tesla Inc. TSLA-Q.

The ETF holds 80 securities in the S&P Midcap 400 Index. The names include Deckers Outdoor Corp. DECK-N, Williams-Sonoma Inc. WSM-N and Super Micro Computer Inc. SMCI-Q.

The securities in this fund have been rising since last fall amid speculation of falling interest rates this year. He says interest rates should come down, but probably not as fast as some people believe.

Rising interest rates are still a risk to this ETF, but the fund’s 0.33-per-cent MER is reasonable given that it involves more fundamental analysis, he adds.

The pick: BMO Equal Weight U.S. Banks Index ETF (Hedged to CDN) ZBK-T

MER: 0.38 per cent

This ETF, which owns U.S. banks, is poised for recovery after facing headwinds last year from rising interest rates and the fallout from the collapse of Silicon Valley Bank, Mr. Hood says.

The fund holds 18 equally weighted bank stocks, including JPMorgan Chase & Co. JPM-N, Wells Fargo & Co. WFC-N and Citigroup Inc. C-N.

When interest rates rise, banks make more money on net interest income – the difference between the interest that banks earn on loans and pay out on deposits – but they also face rising credit losses, he says.

“I like the Canadian banks, but the U.S. banks will have a better recovery in my view, and I like the exposure to the U.S. dollar,” Mr. Hood says.

U.S. homeowners typically have 30-year mortgages while their Canadian peers face more financial pressure with variable or shorter-term mortgages, he adds.

Rising interest rates are still a risk to this ETF, while its 0.38-per-cent MER is still reasonable, he says.

For more from Globe Advisor, visit our homepage.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 14/02/24 11:59pm EST.

SymbolName% changeLast
ROK-N
Rockwell Automation Inc
+0.68%280.51
CAT-N
Caterpillar Inc
+0.56%323.88
VMC-N
Vulcan Materials Company
+0.11%257.23
XETM-T
Ishares TSX Energy Transition Materials Index Et
-1.99%34.56
FCX-N
Freeport-Mcmoran Inc
+0.75%38.96
CCO-T
Cameco Corp
-1.95%54.27
ALB-N
Albemarle Corp
+2.09%120.65
BABA-N
Alibaba Group Holding ADR
-0.21%75.96
PDD-Q
Pdd Holdings Inc
-2.99%127.69
GOOG-Q
Alphabet Cl C
-0.02%145.29
AMZN-Q
Amazon.com Inc
+0.23%174.99
AAPL-Q
Apple Inc
-1%182.52
META-Q
Meta Platforms Inc
-0.43%484.03
MSFT-Q
Microsoft Corp
-0.32%410.34
NVDA-Q
Nvidia Corp
+0.36%788.17
TSLA-Q
Tesla Inc
-2.76%191.97
DECK-N
Deckers Outdoor Corp
-0.4%880.48
WSM-N
Williams-Sonoma
+0.49%226.61
SMCI-Q
Super Micro Computer
-11.84%860.01
ZBK-T
BMO Equal Weight US Bank ETF
+0.19%26.76
JPM-N
JP Morgan Chase & Company
+0.5%183.99
WFC-N
Wells Fargo & Company
+0.92%53.86
C-N
Citigroup Inc
+0.05%55.93
DFJ-A
Wisdomtree Japan Smallcap Fund
+0.2%75.59
KWEB-A
KS CSI China Internet ETF
+0.74%25.94
XMHQ-A
Invesco S&P Midcap Quality ETF
-0.52%100.41

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