ETF investors resist the COVID-19 sell-off

Amid the panic-selling induced by the coronavirus, one cohort of investors has resisted the urge to dump everything: those with multi-asset ETF portfolios.

That's according to Pat Garrett, co-founder and co-CEO of robo advisory Six Park. Garrett says says about a quarter of the company’s client base have topped up their accounts since the sell-off gathered speed in late-February.

"We’re pleased to see that the vast majority of our clients have avoided the panic-selling that ramped up in this type of environment," he says.

"About 25 per cent of our clients are adding funds to their accounts. This suggests that they are seeing the current conditions as an opportunity as opposed to something to be frightened of."

Six Park declined to detail its client numbers but in Australia, a conservative assumption is there are 1.1 million investors with investable assets of between $30,000 and $100,000, according to the Australian Financial Review.

Garrett says Six Park's churn rate – or the level of attrition – has been around 3 to 4 per cent. But he says many who have sold down are retaining their assets in cash (as to opposed to closing their accounts), suggesting that they will likely reinvest.

Data from ETF provider BetaShares also shows investors turned to ETFs to hedge the portfolios in response to coronavirus. Trading value reached a monthly record in February: more than $7 billion traded in Australian ETFs for the first time.

Garrett says there's a level of fear among the client base. While Six Park hasn't released performance figures for March, in February their portfolios fell between 2.6 per cent and 7 per cent. But he says the majority of clients are expressing curiosity and seeking guidance.

"This is pleasing to see because it suggests we're doing our job and investors are being calm and rational," he says.

Six Park is an Australian-founded robo-advice service. Under its model, clients complete a personal risk and investment horizon assessment after which they are placed into one of five multi-asset portfolios of ASX-listed ETFs, which range from conservative to aggressive growth. Fees are collected on account size, meaning a prolonged drop in markets and increased volatility could impact revenue generation and cash flow.

About 15 per cent of Six Park's clients are SMSF trustees, with 25 per cent of assets under management tied to the segment due to their larger average account sizes.

For those piling back in, Garrett says some clients are making substantial lump sum deposits while others are drip-feeding - investing a little at a time, also known as dollar-cost averaging. He says this can help investors manage stress.

Morningstar's Maciej Kowara and Paul Kaplan say that while individual investors often gravitate toward dollar-cost averaging, that historically the practice has produced lower long-term returns than lump sum investing.

An eye on volatility

The Six Park team has been working from home during the crisis. Their custom-built system automates the sign-up process from the creation of an account to the generation of documentation, risk assessments, portfolio construction and even trading. Staff can also complete manual tasks where needed.

Garrett says he is acutely aware of risks associated with trading ETFs during periods of high volatility. Market volatility has led some fixed-income funds in particular to trade at a discount to net asset value. Six Park sends the trades to the open market just before midday, with a limit order, to avoid the high levels of volatility that can occur at market open and close.

"We have a system in place to ensure that we don't trade in highly disjoined market conditions," Garrett says. "We think the ideal time for trading ETFs is generally between 11am and 2pm. We have our default trading set at 11:45am, but we have the ability to change that if need be."

Garrett says the ETFs within the Six Park portfolios haven't experienced serious issues so far. The company's selected ETFs include SPDR's S&P/ASX 200 fund (STW), Vanguard's MSCI Index International Shares ETF (VGS), SPDR's Dow Jones Global Real Estate Fund (DJRE), VanEck's Vectors FTSE Global Infrastructure (Hedged) ETF (IFRA) and iShares's Composite Bond ETF (IAF).

"Our investment committees management review what we would define as the best ETFs available for our portfolio construction and asset class diversification," he says, adding that key characertistics are size and liquidity.

Beyond his portfolios, Garrett says he hasn't seen much evidence of mispricing outside of the bond market. He also rejects suggestions ETFs could accelerate market volatility during a crisis.

"Most of the trading in ETFs have been from one ETF to another," he says. "It's people switching with the ETF universe, seeking to modify their asset class diversification as opposed to a wholesale sell down of ETFs.”

Six Park is continuing to rebalance its portfolio as a normal course of business. Garrett says the magnitude of drift from the portfolio target is less than people would expect because almost every asset class has fallen in value.

"Some clients have requested that their portfolios not be rebalanced, but that's the exception – not the norm," he says. "We think rebalancing remains prudent, but you don't want to do it too frequently as this can lead to capital gain consequences.

"Evidence suggests that rebalancing once a quarter is more than enough."

Diversification can mitigate, but not eliminate, risk

The rationale behind diversification is simple - a diverse portfolio helps reduce volatility because positive performance of some investments neutralises the negative performance of others. But as the coronavirus market sell-off hit, a disconcerting phenomenon unfolded. Asset classes across the risk spectrum fell, including high quality bonds. Worst hit in March was the Australian real estate investment trusts index, down 35 per cent - unsurprising considering the heavy toll the sector has weathered since the start of the coronavirus crisis.

Retail REITs are among most exposed sectors to the virus-lockdown as strict new social distancing rules turn shopping centres into ghost towns. The only index to deliver a positive return (albeit half a percent) in March was the RBA Bank accepted Bills 90 Days index.

Index monthly returns, 1-Yr

Click image to enlarge

Source: Morningstar Direct

Garrett says diversification in Six Park's portfolios has offset the losses in asset classes hit hardest. That buffer has been smallest for the high-risk portfolio and largest for defensive portfolios because of its exposure to bonds and cash.

He believes diversification has worked well, even in these volatile times. The problems occur when people make a medium- to long-term plan and then respond to short-term events.

"When there's a market drop of this magnitude, investors see the value of their holdings drop precipitously," he says.

"That triggers a range of emotions – some helpful some not. The problem that can manifest for a lot of investors is that the actual loss of value is only crystallised if you sell.

"Every market correction or crash in our lifetimes and before has recovered. When and how swift and how much is unclear. Those who remained invested through the GFC reaped substantial rewards. And those that sold into cash and waited were penalised for not being patient investors."

Garrett says short-term investors who haven't diversified or taken on too much risk are the ones that will be caught out.

"If you have a short-term horizon for your cash needs and you've put it all into the share market, you've taken a great degree of risk.

"And there isn't a real pretty answer about how to handle that right now. The overall guidance is that you should put your investable assets into different buckets depending on what your needs are. And if you've failed on that front you've been called out."

Morningstar data shows multi-asset strategies produced wildly different outcomes during the sell-off, largely dependent on their equity exposure.

"The best predictor of performance was asset allocation, more specifically, increased equities equated to worse outcomes," analyst Edward Huynh says in a report that looked at performance for the sector from 21 February through to 25 March.

Returns from balanced funds ranged from -10.28 per cent to -17.45 per cent. These funds are defined as holding a rough 50/50 split between growth and defensive assets, but Huynh says the mix varied significantly, with growth representing between 42 per cent to 66 per cent for the cohort.

The best performer in the category by a significant margin was Perpetual Wholesale Diversified Growth, returning -10.28 per cent due to its underweight exposure to equities relative to the cohort. The worst performing balanced fund strategy was FirstChoice WS Moderate.

"Perpetual had the lowest equity exposure of the cohort with 39.07 per cent aiding the fund against the broad-based equity sell-off," Huynh says.

"Internal allocations to Perpetual's Diversified Real Return Fund further buffered against the downside due to tail risk protection through the purchase of AUD/USD put options."

Multi-asset index performance, year-to-date, growth on $100

Morningstar calculates and publishes proxy market benchmarks for multi-sector funds. These Morningstar Multi-Sector Market Indices incorporate weighted averages of existing market indices. Here's how those indexes have performed since the beginning of the year.

Source: Morningstar Direct

Finding the positives

If Garrett could give one message to investors, it would be to keep calm and carry on. "It's an incredibly important to beat that drum every day," he says.

"Big corrections are big corrections; they come in different shapes and sizes. They tend to come when you least expect it. And they're all frightening in some shape or form. But they all recover in due course.

"The most important things that investors can do at this point in time is to avoid making common investment mistakes."

He says the downturn is also a good opportunity for investors to step back and reflect on their own tolerance for risk.

"One of the common questions you get in a risk profile is 'how would you respond if the market went down 30 per cent in a short period of time?'," he says. "The answers range from sell everything to buy, buy more, with a few pieces in between.

"For a lot of people, they answer it honestly and genuinely at one point in time when things are normal. But when circumstances change, their feelings can change, and that's when poor decisions happen.

"Now is a good time to reflect and get to know yourself as an investor."