This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on March 7 - 13, 2016.

In volatile times like these, exchange-traded funds could play a bigger role in an investor’s portfolio. With some knowledge of macroeconomics and technical analysis, investors could trade in ETFs to generate a higher return. 

Global economic growth is expected to be sluggish this year and the volatility in stock markets shows no signs of abating. In times like these, exchange-traded funds (ETFs), which tend to be overlooked by local investors, could have a role to play in an investor’s portfolio. 

One strategy is to include ETFs in your investment portfolio to broadly ride the market. ETFs also provide investors access to markets around the globe that continue to outperform even in a downturn. With some knowledge of macroeconomics and technical analysis, investors could trade in ETFs during market volatility to generate a higher return. 

ETFs adopt a passive investment approach by tracking the performance of an index and, to a certain extent, the broader market. Mahdzir Othman, CEO of i-VCAP Management Sdn Bhd, says that by allocating a portion of your investment portfolio to ETFs, you can create some predictability in its performance. 

“Let’s say you allocate 20% to 30% of your investment portfolio to ETFs. This part of your investment won’t swing too far away from the market’s performance. The rest of your funds could be allocated to actively managed funds or [individual] stocks. The ETFs will anchor your [satellite] portfolio,” he explains. 

Mahdzir says in a volatile market, investors can also use ETFs to “hedge” against an actively managed unit trust fund, which depends on the skill of the fund manager to pick stocks he believes will outperform the market. An investor could buy into a growth fund that invests in local equities and at the same time, buy into an ETF that broadly tracks the performance of the FBM KLCI, which the unit trust fund is benchmarked against. 

“You are buying into the market when you buy into ETFs, and you are buying into a fund manager’s skill when you buy into a unit trust fund. The two funds can actually complement each other,” he adds.

“When the market does well and the unit trust fund outperforms the market, you could have returns on both sides. If the fund manager doesn’t perform well when the market is good, the ETF — which tracks the broader market — can serve as a hedge.”

Finding opportunities in the broader market

ETFs provide investors with access to diverse markets that they previously had no access to. This allows investors to seek out a wider spectrum of investment opportunities in volatile times. An example can be found in Singapore, home to about 90 ETFs.

Looking at the Exchange Traded Funds Trading Summary December 2015 provided by the Singapore Exchange, the most actively traded ETF last year was the iShares MSCI India Index ETF, which made up 20.2% of the total ETF turnover.

“This is because the firms and investors there could not invest directly in the Indian market. But the market was performing so well at one point last year, so they invested using ETFs. It is an easy way into the market,” says Mahdzir.

Last year, India’s equities market was one of the top picks of fund managers around the world because of its insulation from the global economic headwinds. The oil price crash had sent the emerging markets into a sea of red and slower demand did not bode well for developed nations. However, India was an exception. It benefited from low oil prices as it was a net oil importer and its domestic demand remained robust even as global demand slowed. 

The SPDR Gold Shares, the largest physically backed gold ETF in the world, was the second most traded ETF on the Singapore Exchange last year, making up 16.2% of the total ETF turnover. Gold is seen as a hedge against a global economic meltdown, and the ETF allows Singaporean investors to participate in the gold bullion market without actually possessing one.

From a global view, the Wisdom Tree Europe Hedged Equity Fund was the hottest ETF last year, with the most net inflows at US$13.9 billion, according to a Bloomberg news report. The fund aims to provide investors with exposure to European equities while neutralising exposure to fluctuations between the euro and US dollar. 

This was followed by Vanguard S&P 500 ETF and Deutsche X-trackers MSCI EAFE, which saw a net inflow of US$13 billion and US$12.6 billion respectively. The former tracks the overall US stock returns while the latter tracks an index of developed market equities, excluding the US and Canada, and hedges the euro and yen against the US dollar.

More importantly, Mahdzir says the buying and selling of ETF shares can be done simply by calling a broker to acquire them on the stock market as ETFs are traded like shares despite having a unit trust structure. It also means investors can make an independent decision based on the current situation of the market and make a trade straightaway through a broker.

“The information is at your fingertips in the internet era. So, if you read an analysis or article on the European economy and you decide to ride the European recovery theme in the current market, you can buy into an ETF that tracks the European market,” he says.

There are currently eight ETFs listed on Bursa Malaysia (see table), four of which provide access to Asean and Asian markets — the CIMB FTSE Asean 40 Malaysia, CIMB FTSE China 50, MyETF MSCI South East Asia Islamic Dividend and MyETF Thomson Reuters Asia Pacific Ex-Japan Islamic Agribusiness. To buy into ETFs in other regions, one has to do so via the Singapore Exchange.

Trading during market volatility

AmInvest CEO Datin Maznah Mahbob says ETFs are an ideal vehicle for individuals who adopt a top-down investment approach to take advantage of market volatility. 

“Institutional fund managers like us may have a different investment style. We could have a stock picking style or an asset allocation style between sectors or asset classes. Let’s say a retail investor with a macroeconomic background adopts the latter approach and avoids stock picking or looking at individual companies, he could utilise ETFs to actualise his views,” she points out. AmInvest was the first to launch a bond and equities ETF locally in 2005 and 2007 respectively.

Maznah says the individual investor would have to understand macroeconomic issues such as liquidity flows, currency movements and impact, and market volatility. This compares with a bottom-up stock picker who looks at a company’s fundamentals such as its earnings and balance sheet. “When there is market volatility, an investor like this could use it to his advantage and trade in ETFs to make a return.”

Technical analysis is one of the methods that can be used when trading in ETFs in a volatile market. Maznah says technical analysis was very popular in Malaysia in the early 1980s and is now widely used by investors in the US.

Unlike fundamental investors who look at economic and company data and invest for the long haul regardless of market volatility, technical analysts evaluate stocks and securities by analysing statistics generated by market activity such as past prices and volume. They do not measure securities based on intrinsic value, but use charts and other tools, such as indicators, to identify patterns that suggest a stock’s future activity.

“Technical analysis looks at price movements and momentum. It uses different tools and indicators to measure whether a security is overbought or oversold. Indicators such as head and shoulders, candlestick and the Elliot wave [are used to predict the price movement of a security] and to decide when to buy and sell it,” says Maznah.

“Volatility is expected to be here for a while, and investors worry about it. If you are not a fundamental investor like Warren Buffett, you either fear it or take advantage of it. Applying technical analysis to trading in ETFs is one of the ways to exploit market volatility.” 

Investors with macroeconomic knowledge but without a technical analysis background can access technical analysis reports to get recommendations.

Maznah says trading in ETFs with technical analysis is an “easier” investment approach that can be adopted by individual investors. “That is because you are trading one security that represents the whole market compared with 20 separate securities. You are looking at one volatility compared with 20. And by adopting technical analysis, the same tools and indicators are applied across all securities to look at the price momentum.”

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