Daniel Straus' Top Picks: March 12, 2019

BNN Bloomberg

Daniel Straus , BNN Bloomberg

Daniel Straus, head of ETF research and strategy at National Bank Financial

Focus: ETFs

MARKET OUTLOOK

National Bank’s economists and strategists see the U.S. economy taking a breather after a strong 2018. Even though the year finished on a rough note, the rebound has been sharp and ongoing, and our strategists are keeping their 2019 growth forecast unchanged. However, they see challenges ahead for the U.S. dollar, potentially from a more cautious Federal Reserve.

Canada’s economy has been hampered by stalling consumption, but investment intentions in transportation, finance and manufacturing shine a bright spot on potential growth sources. While Canada should be a core allocation in most Canadian’s portfolios (with an eye to limiting home bias), we’re highlighting some low-volatility strategies this go-round to express our risk-aware positioning.

Our strategists write that the China-U.S. trade war may be de-escalating, but that does not necessarily imply the disappearance of protectionism and its harmful economic effects. The U.S. may still impose tariffs on national security grounds, this time affecting auto imports. Such a move would disrupt global trade with knock-on effects tipping Japan and Germany (both major auto exporters) into recession. With hard Brexit fears also on the horizon, our strategists have therefore de-emphasized developed markets for the coming quarters, tilting more heavily to Canada and the U.S., despite the persistent disquiet in those markets.

With all this turmoil brewing under the surface, how to approach the fixed income side of a portfolio?

Our economists have recently noted that central banks around the world seem to be abandoning their recent conviction of decent economic growth in 2019. However, in the words of National Bank’s chief economist Stéfane Marion, “DO NOT trust the central banks at this point in the cycle,” writing that they “Might turn hawkish soon enough on the back of stronger economic data or better geopolitics.” Given this push-and-pull on the possible pathway of interest rates, we think it prudent to allocate a little towards a broad-based, actively managed fixed income mandate to provide ballast and cushion to a portfolio.

TOP PICKS

BMO LOW VOLATILITY CANADIAN EQUITY ETF (ZLB.TO)

This ETF provides exposure to so-called “low beta” Canadian stocks. Beta is a quantitative factor that measures a stock’s sensitivity to market movements in addition to its volatility. Some academic research suggests that there might be an existing “low volatility anomaly,” which delivers more reward for paradoxically less risk. While we believe the jury is out on what exactly drives this phenomenon, there is no denying that ZLB has been one of the best performing Canadian equity funds (not just ETFs) since its inception in 2011.

WISDOMTREE U.S. QUALITY DIVIDEND GROWTH VARIABLY HEDGED INDEX ETF (DQD.TO)

All of our model portfolios have U.S. equity as a core allocation. While we usually opt for low-cost, pure passive exposure, a strategic “factor-based” ETF can often supplement the passive core and at this point in the cycle, we’re diverting our focus to quality and dividend strategies. DQD builds its portfolio of U.S. stocks by ranking companies based on long-term earnings growth expectations and other quality metrics like return on equity (ROE) and return on assets (ROA). It also has the distinction of being one of the few U.S. equity ETFs with a variable currency hedge, which means its exposure to the U.S. dollar will fluctuate over time, depending on a combination of FX momentum, carry (interest rate differential) and macroeconomic factors. The choice to currency hedge can be as stressful as picking which region, index, or investment product to use and we like the fact that DQD has a dispassionate, rules-based method for outsourcing this often agonizing decision.

HORIZONS ACTIVE CANADIAN BOND ETF (HAD.TO)

In our recent research on active fixed income ETFs, we found that many active fixed income funds do show evidence of outperforming their benchmarks. HAD invests in high-quality Canadian bonds, including governments and corporates. What appeals to us about HAD right now is the ability to turn the dial between governments and corporates, which takes a certain amount of manager skill. HAD is managed by the fixed income experts at Fiera—right now they are long credit, underweight government bonds and slightly overweight financials, real estate and A-rated corps.