ETF Stream’s portfolio of ETFs outperforms in Q1

Reflecting on a Q1 that defied many of the base case elements going into the year, ETF Stream’s portfolio of ETFs has managed to power ahead of the conventional multi-asset allocation so far in 2024.

While some core assumptions – such as midcaps staging a comeback and imminent central bank rate cuts – have yet to materialise, continued US equity dominance and pockets of opportunity in Asia meant ETF Stream’s forecasts gave us an edge through the first 12 weeks of the year.

In fact, while a global 60/40 portfolio – comprised of the iShares MSCI ACWI IMI UCITS ETF (SSAC) and the iShares Core Global Aggregate Bond UCITS ETF (AGGG) climbed 4.8% in US dollar terms in Q1, ETF Stream’s 2024 portfolio stole an advantage with a 5.3% return.

Bright spots

Even though our equity bucket’s 0.5% advantage over SSAC in Q1 was consistent with the broader portfolio, this segment’s top allocations boasted our portfolio’s top performers.

For instance, our joint-largest allocation at 20% – the JPM US Research Enhanced Index Equity (ESG) UCITS ETF (JURE) – booked 11.6% gains, which not only made it our second-best performing ETF during the quarter, but its active ‘index-plus’ approach also saw it edge a 1.5% return advantage versus the largest passive ETFs tracking the S&P 500.

Taking our top spot in performance was the UBS ETF MSCI Japan UCITS ETF (hedged to GBP) (UB0D) – at a 7% allocation – as Japanese equities tore ahead of all-time-highs achieved more than three decades ago.

Crucially, by currency hedging Japanese equities, the ETF booked 18.1% gains during Q1, 7% ahead of the equivalent unhedged ETF which continued to see performance stymied by relative yen weakness.

Ironically, despite our fixed income bucket finishing in marginally negative territory – down 0.8% – our portfolio maintained a relative advantage, with AGGG dropping 1.3% in Q1.

As markets heavily repriced the number of Federal Reserve interest cuts from six, to no more than three, our joint heaviest weighting in this segment at 10% – the iShares $ Treasury Bond 0-1yr UCITS ETF (IB01) – shone through with 1.2% gains, owing to its low effective duration of just 0.31 years.

Telling a different story, the iShares Core € Corp Bond UCITS ETF (IEAA) – at a 4% allocation – added 0.6% after markets priced in more than 100 basis points (bps) of European Central Bank (ECB) rate cuts in 2024 after an upbeat policy meeting in March.

Where we got it wrong

Elsewhere, while equal weighting makes sense when constructing portfolios in concentrated markets, our joint-highest 20% allocation to Xtrackers S&P 500 Equal Weight UCITS ETF (XDEW) took some sting out of our US exposure, with a comparatively limp 7.8% gain.

XDEW was among the top picks for fund selectors last year, amassing $2bn inflows in 2023 as many looked to increase their US exposure while minimising their ‘magnificent seven’ focus and capitalising on some size premium during an economic recovery. However, this has yet to bear fruit, with mega caps such as Nvidia still making history with record quarterly earnings.

Elsewhere, the surprise uptick in the US Consumer Price Index (CPI) in the early weeks of the year – and subsequent delays to rate cuts – were a bitter pill to swallow for much of the ETF Stream portfolio, which is positioned for a pivot.

Casualties across asset classes included our 3% allocation to the iShares Developed Markets Property Yield UCITS ETF (DPYA) – with a 2.1% loss – as REIT borrowing costs remained elevated for longer, while the 4.8% position in the SPDR Bloomberg Emerging Markets Local Bond UCITS ETF (SPFA) fell foul – with a 1.4% loss – owing to US dollar strength.

However, our greatest pain point was our punchy 10% allocation to the iShares $ Treasury Bond 20+yr UCITS ETF (DTLA), which fell 3.1%.

While many fund selectors have moved along the US Treasury yield curve in recent months, employing a ‘barbelled’ approach, our reach out to the long end of the curve will provide protection if the US enters a recession and the Fed cuts rates faster than market expectations.

As with our other duration plays, their hopes of staging a comeback through the remaining nine months of the year will be subject to future CPI prints, messaging and actual policy moves from the Fed and ECB.

Wishlist shifts

Our editorial team pieced together a list of 14 ETFs for 2024 in December last year, with the understanding that we would not be allowed to reshuffle these allocations through the year.

However, playing the part of an active manager, that does not stop us from getting itchy feet and highlighting areas of adjustment and potential opportunities.

Among these, we would likely remove the currency hedge on our Japan equity exposure following the Bank of Japan’s decision to increase its policy rates for the first time since April 2007 at the end of Q1 – potentially signalling a bet against the yen may not be the sensible move it has been for the past 17 years.

Elsewhere, we took the bold step of allocating a small portion of our equity bucket in favour of China staging the early phases of a comeback.

While this took the form of a 3% allocation to the Invesco S&P China A 300 Swap UCITS ETF (CA3S), we would instead look to take a targeted approach to the most ailed equity sector of the past four years by shifting to a China tech ETF.

Finally, the ECB’s comparatively dovish messaging versus the Fed would have prompted us to consider euro government bonds and even swapping out our US for European small caps, which on a composite index basis are at their lowest P/E ratio since 2009.