Investment Research

Key Takeaways Recent market volatility has encouraged investors to position portfolios more defensively ETF Securities has a selection of products more suited to a defensive strategy ZYUS gives a low volatility approach to the US market CORE gives exposure to the historically more stable infrastructure sector GOLD provides the best-known hedge against equity market downturn and political instability Introduction Investors have battened down the hatches over the past weeks as waves of volatility have dominated the market. Maybe the market calms down and equities resurge, but now, is clear, that late cycle volatility is here and will probably become more violent at each episode. The recent equity sell-off has heightened uncertainty, with consumer sentiment nicely described by the CNN ‘Fear and Greed Index’ that looks to characterise the primary emotion driving the market (see below). Right now, this index sits at 11, or ‘extreme fear’. Why? The consensus among investors appears to be that we’re in the ‘late stage’ of the investment cycle. Wall St’s thundering run has lasted a decade – the longest ever. And the market has become increasingly wary because of that. We have seen a very large sell-off in technology sector stocks with the Nasdaq, which is often taken as a proxy for US tech, recording its worst month since 2012. This suggests that some are losing faith in the continued performance of our recent equity stars (otherwise known as team FAANG). Adding fuel to the fire, the world has been curiously watching on as China and the US continue their game of trade policy tag. As the reverberations of any decisions by these heavyweights are felt by all, this tension is creating a difficult environment for investors. Playing Defence Though we are all familiar with the old adage ‘past performance is not an indicator of future performance’, it is sometimes helpful to look back at how previous storms have been weathered. The traditional market response to a late cycle downturn can generally be characterised by a move away from higher risk equities such as technology or emerging markets, greater focus on essential sectors such as healthcare, utilities and energy, and a general movement away from equities and into cash, short-term fixed income and commodities. As the bull market nears the close of its tenth year many are considering if now is the time to reposition portfolios towards ‘defensive’ assets. So, what are the options for investors looking to rearrange their holdings into a more defensive position? ** Gold is not considered in the risk illustration for two reasons. First, there is no counterparty risk with gold whatsoever (with cash there is still sovereign risk). Second, gold has historically had low correlations with equities, so its risk characteristics work differently. Defensive Equity Solutions America If you take a glance at global headlines, the US right now may seem a difficult market to play, with high levels of uncertainty around international policy and tariffs. However, as the world’s dominant economy, many would wish to maintain some sort of equity exposure but with a defensive tilt and an eye on capital preservation as much as growth. The ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) is one option that is designed to achieve this. As suggested by the name, this ETF has a low volatility filter built into its index construction. The underlying assumption is that companies that don’t exhibit aggressive price movements are less likely to be sold down heavily in a general market sell off. Specifically, the index universe (the S&P 500) is ordered to select the 75 highest yielding stocks and then the 50 least volatile of those 75 are selected creating a high dividend paying, relatively low risk portfolio based on the trailing twelve months of price data. With reference to the chart above it is clear to see that, since the VIX jumped in October, IVV has lost approximately 10% whereas ZYUS has only lost 4%. Part of the reason for this is because ZYUS has a 16% greater exposure to utilities (historically low in volatility) whilst a 17% less to information technology (historically high in volatility) (as at 30th August 2018, source: S&P). Infrastructure Another strategy investors may consider in times of heightened volatility is increasing the allocation to sectors that have historically had greater stability. One such area known for this is infrastructure. The source of this stability can be explained by looking at the industries that fall into this sector: utilities, telecoms, industrials and transport. These industries typically have high capital costs, low elasticity of demand, long business timelines and often exist as regulated oligopolies or monopolies. Their capital-intensive nature means that they are very difficult and, in some cases, like energy distribution networks, nigh impossible to disrupt. This can mean that these sectors have lower risk (as measured by standard deviation of returns) than other sectors, such as technology or real estate. The table below illustrates the substantially lower volatility of infrastructure against these sectors.

ETFS Trade idea:  US Defensive Equities Starting to Look Well Valued ETFS S&P 500 High Yield Low Volatility ETF ASX Code: ZYUS U.S. market has been high growth since Trump’s election This cycle looks like it may be turning Investors wanting to retain U.S. exposure but remove the high growth/high volatility companies should look at ZYUS In this week’s ETFS Trade idea, we look at opportunities in defensive U.S. equities and show how it may be a good entry point for ZYUS, which under performed the broader market in 2017, but has picked-up in recent months and had standout performance in 2016. ZYUS tracks the S&P 500 Low Volatility High Dividend Index, which selects a portfolio of the lowest volatility stocks from amongst the highest yielding names in the S&P 500. The story in 2017 - defensives appeared to be out of favour For most of 2017 the U.S. economy was in expansionary territory with GDP growth rising above 4%, the S&P 500 returning 22%, volatility remaining persistently low and normalisation of monetary policy accelerating. Information technology stocks dominated, returning 39%, but other traditional growth sectors also outperformed. Materials, consumer discretionary and financials all beat the benchmark. Defensive sectors, which traditionally include utilities, consumer staples, health care and real estate, on the other hand, suffered on two fronts. Firstly, the economic conditions of a growing economy and rising interest rates were not conducive to above-market performance in sectors such as utilities, consumer staples and telecommunications. Secondly, many companies in these sectors had become over-bought and over-valued in the post-crisis scramble for stable returns and yield, where low volatility and equity-yield strategies gained significant popularity. With rates rising and bonds starting to look more attractive, asset allocations shifted causing under-performance in defensives in 2017 and into early 2018. What has happened so far in 2018? 2018-to-date has seen the U.S. move further into expansionary territory, with GDP growth now sitting at 4.7% and the Federal Reserve having raised rates twice so far. However, signs of the expansionary cycle moving into a later phase have started to appear in recent months. Long-term bond yields have stabilised, inflation has picked-up and the S&P 500 has returned only 2.6% year-to-date. In addition, through a combination of geo-political and economic events, volatility has returned, with the VIX peaking at 37.3 in February and averaging 16.3 in 2018 compared to a maximum of 16.0 and an average of 11.1 for the whole of 2017. Defensives are currently looking more attractive on a valuations basis than at any time in recent years. On a relative-PE basis, utilities, consumer staples, telecommunications and health care sectors are all currently trading at lower multiples than the S&P 500. Even if the bull market still has further to run, now could be a good opportunity to re-allocate back towards defensive sectors. While the economy is not yet showing any signs of slowing, if you believe the U.S. is currently in a late-cycle boom, then it may be prudent to prepare for a sell-off in risky-assets. How does ZYUS’s sector allocation look? As can be seen in Chart 1, ZYUS is currently most overweight real estate and utilities along with smaller over-allocations to consumer staples, energy and telecoms. Information technology, health care and financials are the biggest under-weights. Overall, relative to the S&P 500, ZYUS is 34% overweight to the traditional defensive sectors, despite being 10% underweight health care, which is no longer considered to be as defensive as it once was. How has ZYUS performed relative to the S&P 500? In 2017 ZYUS underperformed the S&P 500 by nearly 9.6% as technology stocks accelerated away. This continued into early 2018 with ZYUS under-performing heavily in both January and February as the sell-off in defensives picked-up pace. This contrasts with 2016, where ZYUS outperformed by 8.8% . Monthly performance differentials are shown in Chart 3, below. Since the end of February, however, ZYUS has outperformed in three of the four months and added 4.7% to the S&P 500 on an AUD total return basis. Volatility-wise, on a 90-day historic basis, the spread between the S&P 500 and the S&P 500 Low Volatility High Dividend Index is currently at its lowest since 2012, as shown in Chart 3. Recently the low volatility screening is providing a degree of risk-reduction even in a more concentrated, 50-stock portfolio. On a yield basis, the S&P 500 Low Volatility High Dividend Index is currently yielding 4.3%, which is more than double the yield on the S&P 500 at 1.9%. Lastly, it is worth recalling that, despite the recent under performance, the low volatility/high dividend strategy has outperformed the S&P 500 by over 6% pa since the beginning of 2000, which demonstrates its ability to outperform across cycles. How ZYUS invests ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) follows a rules-based strategy, tracking its benchmark Index, and has the following features: ZYUS captures the performance of a selection of the high yielding companies from the S&P 500 Index and aims to provide stable returns with regular income. ZYUS selects the 50 lowest volatility names from a list of the 75 highest yielding stocks at each rebalance. ZYUS is rebalanced semi-annually in January and July. ZYUS is weighted in proportion to the dividend yield of each constituent, meaning that the stocks with the highest yields receive the highest weightings. ZYUS applies individual stock and sector caps to ensure diversification. ZYUS has an MER of 0.35% p.a. ZYUS has a Recommended rating by Lonsec. Summary While low volatility and defensive sector strategies have underperformed over the past 12 to 18 months, with the U.S. possibly moving towards the latter stages of the current economic cycle, it could be a good time to revisit these strategies. ZYUS provides a generally more defensive sector allocation than the broader market, uses a low-volatility screening and produces a consistently higher yield.

ETFSTrade idea – Conflicting signals in the U.S. - Time for caution? ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) ETFS Physical U.S. Dollar ETF (ZUSD) The U.S. economy continues to surprise to the upside with markets rebounding strongly. Yet rising inflation, subdued long-term rates and geo-political risks remain a concern. For a defensive U.S. equity exposure, investors should consider ZYUS. Avoiding equity-risk and looking for currency? Consider ZUSD. In this week’s ETFS Trade idea, we look at the outlook in the U.S. for monetary policy, the economy and the dollar. We highlight two funds that can be used in different ways to play the U.S. story; ZYUS and ZUSD. Rate rises on the horizon… Market expectations for multiple rate rises from the U.S. Federal Reserve in the remainder of 2018 have firmed in recent weeks. The economy is still in expansionary territory, though inflationary concerns are becoming more pertinent. US Core CPI rose to 2.1% in March, its highest level in over a year, while March PPI numbers also exceeded expectations. The Fed Beige Book reported strong economic activity, but showed significant business concerns around Trump’s planned steel and aluminium tariffs. Figure 1 below shows the current probabilities the futures market is implying for Fed activity for the remainder of 2018, with two further hikes narrowly the most likely outcome. ...but longer-term growth concerns are becoming more pronounced. While short-term yields have been rising, the yield curve has seen a substantial flattening, with the difference between 2-year and 10-year Treasury yields at their lowest since late-2007 (see Figure 2). Speculation of a curve inversion is starting to emerge. Historically this would indicate that the peak of the current rate cycle is approaching and present a subdued outlook for growth. U.S. dollar weakness continues… Despite rising short-term rates, the U.S. dollar has been in a steady down-trend since early 2017, as shown in Figure 2. This can be partly attributed to President Trump’s rhetoric regarding trade and towards China, but also to a gradual unwinding of GFC-era flight-to-safety trades. …but political risks could be a catalyst With the impositions of tariffs and a potential trade with China, military action in Syria, sanctions against Russia and talks with North Korea on the horizon and February’s equity market volatility still fresh in the memory, there is no shortage of event risk candidates looming. With external events and any evidence of longer-term U.S. economic strength both likely to have a positive impact on the dollar, it appears that near-term risks may lie to the upside. Why ZYUS? ZYUS invests in U.S. stocks from the S&P 500 screened for both high yield and low volatility. As such, the fund tends to be overweight defensive sectors like utilities and real estate and underweight more volatile sectors like technology and financials. The S&P 500 Low Volatility High Dividend Index, which ZYUS tracks, has outperformed the S&P 500 by over 3.6% per annum over the past 10 years and has outperformed on a monthly-basis in over 70% of months during which the S&P 500 has posted a negative return. After underperforming the S&P 500 by over 9.5% in 2017, mainly due to its underweight to technology, ZYUS has recently picked up. Outperformance in March 2018 was over 3% as volatility hit the tech sector and risk-aversion appeared. ZYUS should be considered by investors wanting to maintain U.S. equity exposure, but take a more cautious view on growth and the landscape ahead. Why ZUSD? Investors looking for pure exposure to the U.S. dollar strengthening against the Australian dollar without taking on any equity risk may consider ZUSD, which tracks the exchange rate by investing in short-term USD deposits. How ZYUS invests ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) is well positioned for investors for the following reasons: ZYUS captures the performance of a selection of 50 high yielding U.S shares selected from the S&P 500 Index and rebalanced twice annually. ZYUS initially screens stocks based on dividend yield, reducing the 500 stocks down to 75. ZYUS then selects the 50 stocks with the lowest volatility for inclusion and weights them according to their dividend yield. ZYUS has an MER of 0.35% p.a. ZYUS has a Recommended rating by Lonsec. How ZUSD invests ETFS Physical U.S. Dollar ETF (ZUSD) is well positioned for investors for the following reasons: ZUSD captures the performance of the U.S. dollar against the Australian dollar, by investing all of its assets in U.S. dollar bank deposits. ZUSD currently holds overnight USD deposits with Australia and New Zealand Banking Group Limited (ANZ), earning interest at 1.30% p.a. ZUSD has an MER of 0.30% p.a., making it the lowest cost U.S. dollar exposure available on the ASX. ZUSD has a Recommended rating by Lonsec.

Is AUD/USD risk on the downside? ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) Key Teakeaways: The AUD/USD exchange rate is currently close to 2 year highs, at just below US 80c. US rate expectations pulled back in July as political developments have cast uncertainty over the pace of US reforms and growth. Investors with a view that the USD is undervalued or the AUD is overvalued can play a reversal via ZUSD, which is the most cost effective way to access direct US dollar exposure with an ETF. A declining USD has been the key theme in foreign exchange markets this year. The AUD has gained more than 8% from its mid-May lows, while the US Dollar Index (DXY), a measure of the value of the USD against a collection of major world currencies, has dropped nearly 7% over the same period. As shown in Figure 1 the recent appreciation of the AUD has been particularly steep, with the currency peaking at US 80.66c in late July, while the DXY has been in a downward trend for most of 2017, falling over 10% from its peak in the final days of 2016. Chaotic administration weighing on the US dollar. With the Russia investigation, continual changes in key personnel and failures to negotiate Congress, the Trump administration is failing to meet the lofty expectations set by the market last November. Whilst the Fed is now considered likely to raise rates only once more this year, the US economy is generally in good health. US 10 year treasury yields have fallen by just over 10 basis points since the start of July, suggesting that the long-term monetary policy outlook is relatively unchanged. With temporary factors and uncertainty being the main drivers of the lower dollar, a swift reversal is a possible scenario if confidence is restored. Last Friday’s US employment numbers, which exceeded analyst expectations, were an example, with the DXY jumping 0.75% almost immediately. RBA talking AUD down. The strength of the AUD has in part been a result of a shift in the expected direction of the RBA’s next rate move. However, the RBA last week noted that the higher currency is a concern for growth and cut its estimates for 2017 GDP growth by 0.5%. Further validation of a slowdown could quickly shift AUD sentiment to a bearish stance. What does this mean for investors? Investors wishing to express a bullish USD/bearish AUD view may consider the ETFS Physical US Dollar ETF (ZUSD) . ZUSD offers exposure to an appreciation of the USD against the AUD with a management fee of 0.30% per annum, making it the most cost effective ETF offering this exposure in Australia.