The flow of capital into passive investing has fuelled the growth of index funds. Now, hundreds of low-cost index funds can provide investors exposure to all of the major equity markets around the globe. During periods of calm, index fund returns across markets correlate strongly with the high confidence investors being extremely infectious. The FOMO (fear of missing out) means that all markets tend to bid up all at once.
It is only during volatile periods as the stock market volatility picks up and confidence begins to falter that the returns of the best index funds tracking markets supported by strong fundamentals will start to diverge from those that were purely supported by faith.
ETF or popular low-cost index funds provides a cheap and easy way to access various markets.
Read More: What to look for in ETFs vs Index Funds
A portfolio of index funds extends the idea of diversification across a portfolio of shares. It can provide diversification benefits by spreading exposure not just in a particular country (i.e S&P/ASX 50) across several divergent markets such as China for emerging market exposure to S&P500 for developed market exposure.
A portfolio invested in exchange-traded funds can further increase resilience and non-correlated returns in the portfolio during stressful times. The table below highlights some of the best ETFs in each major sector. The evidence shows in the post COVID-19 period there is a real spread in the returns between the best index funds and the worst.
Best Index Fund List
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So far in the crisis, comparing best performing index funds shows the best ETF ASX listed to date has been the international ETFs, which tracks the S&P 500 and the technology-heavy Nasdaq.
Unfortunately for investors that thought they were protected by owning the index funds tracking the ASX. The domestic ASX indices have fallen more due to extensive exposure to financials as a result of investors’ dislike of bank’s dividend cuts or freezes.
Another factor contributing to the outperformance of the international ETF is the fall in the Australian dollar, which has buffeted a large portion of the decline. Even some funds have shown positive returns to date.
Picking the right sector exposure
In any investment environment, there are always winners and losers. Sometimes it pays to narrow down market exposure to specific industry sectors. For example, the financials are underperforming, but they are not the worst, and the table shows some obvious winners.
Winners: Healthcare ETF and Technology ETF
It is undoubtedly Healthcare and Technology sectors have been the outsized winners following the spread of Covid-19. The shutdowns saw an accelerated shift to online from increasing streaming (Netflix) to eCommerce (Amazon). Similarly, the increase in healthcare spending has an obvious positive implication on healthcare shares.
It is easy to pick winners in hindsight, but the market is an aggregate representation of all of the stocks listed. Still, underneath the headlines, there are wide divergences between different sectors’ performance depending on the point in the cycle.
Losers: Property ETF
The loser to date aside from the financial heavy local markets is the real estate sector. When rental income makes up a large portion of your returns and tenants suddenly stop paying rent will have flow-on implications on asset value, cashflow and ultimately, long-term returns. On top of poor forward fundamentals from a capital flow perspective, the liquid REIT market has been a proxy hedging tool for those with considerable unlisted real estate exposure, which has further depressed the sector performance. Sometimes you take liquidity where you can get it.
Steady as she goes: Fixed Income ETF
We included a credit ETF to highlight the importance of fixed income’s contribution to the portfolio’s overall risk and reward profile. The return of fixed income shouldn’t be as high as equity as they have a lower risk given their higher capital stack position.
The best Australian dividend ETF, which invests in shares that tend to have a sustainable income, can be a better alternative for those looking for a higher rate of income stream and the ability to take a higher degree of risk.
It is not always about the costs.
The big 3 ETF providers State Street, Vanguard and Blackrock, has reduced index fund fees so much that it almost makes an immaterial impact on return. Most of the saving in costs has already been made for those looking to buy index funds by switching from an actively managed fund to passive investments in their portfolio (see ETF vs managed fund).
The next step is to focus on portfolio allocation and make sure the right investment exposure is made, which means it sometimes makes sense to have diversified portfolio index funds.