B8 G THE GLOBE AND MAIL | TUESDAY, FEBRUARY 13, 2018ETFS

When it comes to invest-ing, vice can sometimesbe nice.

Owning so-called sin stocks,such as companies involved withtobacco, alcohol, casinos, armsand cannabis, potentially can berewarding. While moreexchange-traded funds (ETFs) of-fer exposure to this naughtyniche, investors need to checkunder their hood and assess theirrisk tolerance before jumpingonboard.

Alcohol and tobacco stocks areparticularly compelling because“they are recession-resistant – ifnot recession proof,” says DanAhrens, chief operating officer ofU.S.-based AdvisorShares Invest-ments and author of Investing inVice. “They have been steady per-formers for decades and are verygood dividend payers. … Tobaccoalso has the largest profit marginof any consumer product.”

Mr. Ahrens’s background inthis niche stems from a stint asthe first of several managers torun the USA Mutuals Vice Inves-tor mutual fund launched in2002. Since inception, this fund,which invests in the alcohol,tobacco, gaming and defenceindustries, has outpaced the S&P500 Index, including dividends.

Now, he is the portfolio man-ager for the relatively new active-ly managed U.S.-listed Advisor-Shares Vice ETF, which investsonly in tobacco, alcohol and can-nabis-related names. “There isgoing to be a big overlap betweenthe alcohol and tobacco indus-tries and legal cannabis,” he pre-dicts.

For instance, U.S. beer andwine giant Constellation BrandsInc. last fall bought a near 10-per-cent stake in Canadian marijua-na producer Canopy GrowthCorp. to collaborate on cannabis-infused drinks.

Because marijuana is not legalfederally in the United States, hisETF invests only in ancillary com-panies such as AbbVie Inc.,which markets a cannabis-baseddrug, and Scotts Miracle-Gro Co.,whose hydroponic businessallows cannabis and other plantsto grow indoors.

When investing in U.S.-listedETFs holding cannabis stocks,investors need to “look under thehood” for regulatory risk, Mr.Ahrens warns. Some U.S. stateshave legalized marijuana, but “itis federally not legal to investdirectly in marijuana compan-ies,” he said. “Domestic [U.S.]funds could be forced to divestfrom their illegal investments. …It is different in Canada, ofcourse.”

ETF Managers Group LLC,which markets the SpiritedFunds/ETFMG Whiskey and Spir-its ETF, launched the ETFMG Al-ternative Harvest ETF in Decem-ber. This is the first U.S.-listedmarijuana fund and was convert-ed from an existing real estateETF.

Because this fund tracks someCanadian cannabis companies,U.S. Bancorp is reviewing wheth-er to remain as the ETF’s custo-dian to avoid running afoul ofthe law. If it walks away, and areplacement is not found, thisETF may be liquidated.

More Canadian-listed canna-bis ETFs, meanwhile, are rollingout to get ready for legalizationof recreational marijuana bysummer. Unlike their index-ori-ented peers, Redwood MarijuanaOpportunities ETF and EvolveMarijuana ETF use an activelymanaged strategy for their can-nabis funds.

While the marijuana niche hasbeen a hot play recently, NationalBank Financial ETF analyst Dan-iel Straus cautions investors toapproach the more volatile can-nabis equities differently fromtheir established sin-stockspeers.

The alcohol and tobaccoindustries have been very profit-able, and their stock valuationsare typically lower than thebroader market possibly becausesome investors avoid them, hesaid. “They are … a source of val-ue.”

But cannabis stocks are anoutlier because there is so muchspeculative interest in them, hesaid. “There is a lot of uncertaintyand a lot of very high valuations.

Some of these companies havebillion-dollar market-caps, zerorevenue and negative earnings.… Any future growth may bepriced in [the stocks].”

Cannabis ETFs are suited toaggressive, growth-orientedinvestors with a time horizon of10 to 20 years, and who could sus-tain a total loss, he suggested.While these ETFs are risky, thereis also possibility for “enormousfuture returns.”

For instance, the HorizonsMarijuana Life Sciences ETF,which listed at $10 a unit lastApril, more than doubled to the$24-per-unit range last month. Ithas since pulled back to $18 amidthe market downturn.

Alex Bryan, an ETF analyst atChicago-based Morningstar Inc.,suggested that it’s better toapproach sin-stock ETFs as shor-ter-term, tactical plays. “Thereare times when you may wantthis exposure, and times whenyou may not,” he said.

The gaming sector tends to be“a little more cyclical,” Mr. Bryannoted. “A lot of people treat casi-no visits as an entertainment ordiscretionary expense, so [thissector] tends to do better whenpeople have more money tospend.”

While alcohol and tobacco aremore defensive sectors, “you stillhave a bit of risk if, let’s say, peo-ple continue to reduce theirtobacco use,” he suggested. Can-nabis is more of an emerging-growth story and “basically a beton relaxing restrictions on theuse of cannabis in the UnitedStates and other markets,” hesaid.

“But there is still a lot of uncer-tainty about how the regulationswill shake out, especially in theUnited States, in terms of enfor-cement,” Mr. Bryan echoed.“There are certainty a lot of risksassociated with that particulartrade.”

Special to The Globe and Mail

Pros and cons of investingin naughty themesETFs that focus onso-called sin stocks can be risky, but thereis also possibility for‘enormous’ returns

SHIRLEY WON

Investors need to assess their tolerance for risk before diving into, fromtop, cannabis, alcohol or tobacco-related themes. COSTAS BALTAS/REUTERS (TOP), ISTOCKPHOTO (MIDDLE), CHRISTIAN HARTMANN/REUTERS

Despite the stock market’s recent volatility, most inves-tors have been very pleased with its strong perform-ance over the past year or so. Just about every major

equity index is trading close to a record high.But the stellar market performance also has a downside,

especially for investors who are strict about only buyingstocks that haven’t climbed to an overinflated price.

The challenge is: How do you find value in this marketenvironment?

One answer may be to look for exchange-traded funds(ETFs) that offer a way to buy into stocks that have been leftout of this record-setting market rally.

“Generally speaking, stocks are certainly more expensivethan they were one or two years ago,” says Lindsay Patrick,director of Global ETF Strategy at RBC Dominion SecuritiesInc. in Toronto.

She notes the combined ratios of stock price to forecastedprofits (forward P/E) for all major stock indices have climbedwell above historical averages, though they are still below ahistoric high. However, she sees room for further advances,as earnings estimates rise because of a combination of astronger global economy driving improvement in revenue,lower corporate tax rates and added share buybacks.

Ms. Patrick says the benefits of owning ETFs apply for val-ue investing, just like they do for any other market focus youmay be looking for. Those benefits include liquidity, lowexpense ratios and diversification beyond individual stock-picking.

“ETFs can also offer direct exposure to certain sectors orgeographic regions that investors may feel are undervalued,”she says. She notes investors need to be aware of the sectorexposures for value funds. Currently value funds tend to havemore of an exposure to cyclical sectors such as energy andmining, as well as financials.

As far as specific recommendations go, Ms. Patrick hasthree picks that focus on three separate geographies. For Ca-nadian exposure, she recommends the BMO MSCI CanadaValue ETF (ZVC). This is a new ETF, launched in the fall of2017. The fund has one of the lowest management expenseratios (MERs) of the Canadian value ETFs, at just 0.40 percent. Stocks are selected using three variables: book value toshare price, forward price to earnings ratio, and dividendyield.

“It’s well diversified into 49 different stocks and across avariety of industries,” Ms. Patrick says.

For global exposure, Ms. Patrick favours the iShares MSCIEAFE Value ETF (EFV). This fund is based on value stocks inEurope, Australia and the Far East. It has more than US$6-billion of underlying assets and has been trading for morethan 12 years.

“Canadian investors generally are overexposed to U.S. andCanadian stocks, so this ETF provides international exposurewith a value overlay in one ticker,” she says. The fund holdsthe stocks of almost 500 large-cap, blue-chip internationalcompanies with the largest exposure to Japan, Britain,France and Germany.

Ms. Patrick’s selection for U.S. exposure is the VanguardValue ETF (VTV). This is a well-established ETF that launchedin 2004 and has almost US$38-billion in assets under man-agement. The fund invests in 330 large-cap U.S. stocks basedon five stock price-based valuation measures. The MER isvery low, at just 0.06 per cent. “The largest sector exposure isU.S. banks – a sector we are positive on given the opportunityfor earnings updates, higher divi-dends and tax reform,” says Ms.Patrick.

While the market’s strong per-formance has made value morescarce, some investment manag-ers don’t seem to be having diffi-culty putting money to work. “Isit tough to find value right now?No is the short answer,” says Rob-ert (Hap) Sneddon, president andportfolio manager at Castle-Moore Inc. in Mississauga.

He says there is value withinindividual sectors – namely,stocks that have lagged the per-formance of that group. As well,he notes there is value in sectors that have underperformedthe overall market, such as energy, base metals and industri-als.

Mr. Sneddon says there are at least two ways ETFs can be agood way to value-invest. The first is as an efficient way totake advantage of undervaluation in a specific sector of themarket. He notes that an ETF ensures you get the generalmove and have safety in numbers as the sector fluctuates.

“Buying the complete sector in one shot can be better thanbuilding your own basket,” he says. “It can help prevent yougetting burned by buying the wrong stock.”

The second situation is if an investor feels value will bebetter than momentum or growth styles over a specific timeperiod. Then an ETF can be bought that tracks a value indexsuch as the U.S. Large Cap Value Index (CRSP).

For specific value ETF suggestions, just like Ms. Patrick, Mr.Sneddon recommends the Vanguard Value Index Fund(VTV). He likes its diversification, citing its investment inenergy, financials, consumer staples and technology.

Mr. Sneddon’s second recommendation is the iSharesS&P/TSX Global Base Metals Index ETF (XBM). He says thatwith the trend of global economic growth and central bankinterest rate increases, industrial/base metals offer one of thebest upsides in the next six months.

He points to increased infrastructure activity, dwindlingcommodity stockpiles and few new mine projects as tail-winds for the sector in 2018.

Special to The Globe and Mail

Among the benefits of ETFs are liquidity and low expenseratios, says Lindsay Patrick of RBC Dominion Securities.

How to find valuein a volatile market

ETFs can help you buy into stocks that havebeen left out of the long market rally

TERRY CAIN

Buying the completesector in one shot ...can help prevent you

getting burned bybuying the wrong

stock.

ROBERT (HAP) SNEDDONPRESIDENT AND PORTFOLIOMANAGER, CASTLEMOORE

INC.

AdvisorShares Vice ETF(ACT) invests in U.S. alcohol,tobacco and cannabis-relatedstocks. Holdings include Constel-lation Brands Inc., Philip MorrisInternational Inc. and AbbVieInc. Its fee is 0.75 per cent.

VanEck Vectors Gaming ETF(BJK) focuses on casinos, casinohotels, sports betting and gam-ing companies. Holdings includeGalaxy Entertainment Group Ltd.and Las Vegas Sands Corp. Thefund charges a 0.67-per-cent fee.

Horizons Marijuana Life Sci-ences ETF (HMMJ) invests inNorth American cannabis andcannabis-related firms. Topnames include Aurora CannabisInc. and Canopy Growth Corp.The fee is expected to be justover 0.75 per cent.

Redwood Marijuana Oppor-tunities ETF (MJJ), which usesan actively managed strategy,invests in cannabis or cannabis-related firms. It is also sold as amutual fund. The fee is expectedto be just over 0.75 per cent.

ETFMG Alternative HarvestETF (MJ) owns North Americancannabis and cannabis-relatedfirms. Holdings include Canada-based Chronos Group Inc., Aur-ora Cannabis and CanopyGrowth. The fee is 0.75 per cent.

Evolve Marijuana ETF(SEED) is an actively managedportfolio. Canadian stocks makeup 94 per cent of the fund. TheETF charges a 1-per-cent fee.

Spirited Funds/ETFMGWhiskey & Spirits ETF (WSKY)invests in companies producingand selling whisky and spirits.Top names include Diageo PLCand Pernod Ricard SA. The fundcharges a 0.60-per-cent fee.

Shirley Won

Ways to add vice to a portfolio

WAYS TO ADD VICE TO A PORTFOLIO

THE BENEFITS OF ETFs.IN ONE SIMPLESOLUTION.

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ETFs | MUTUAL FUNDS | PRIVATEWEALTH POOLS | MANAGED ASSETS

WITH A STOCK MARKET ASHOT AS THIS ONE, it’s easy to

forget that when it comes to invest-

ing, what goes up must come down.

At some point, this eight-year bull

run will reverse, and many investors

could be in for a rude awakening.

Even though markets are reaching

record highs – the Dow Jones

Industrial Average hit 26,000 for the

first time in mid-January – investors

can’t forget about risk management,

one of the most important, but often

neglected, aspects to investing.

“Different factors can increase

portfolio risk, such as economic,

political and geopolitical issues,

weather and high valuations,” says

Michael Cooke, Senior Vice-President

and Head of Exchange Traded Funds

for Mackenzie Investments. “The

prudent approach is to diversify a

portfolio across the different risk fac-

tors. You can then mitigate downside

risk and keep more of your capital

working for you over the long term.”

Fortunately, protecting a portfolio

has never been easier. Over the last

few years, numerous exchange-trad-

ed funds (ETFs) have come to

market that enable investors and

their advisors to create diversified,

risk-mitigating baskets of securities

for a low cost.

KNOW YOUR TOLERANCEEvery investor approaches risk

differently, says Cooke. Some people

are fine with putting their money in

the riskiest of assets and can tolerate

a big loss. Others can’t handle more

than a minimal decline. Most are

somewhere in between, but it’s up

to the individual to decide where

they fall on the risk spectrum.

“Investment risk is a personal

thing,” says Cooke. “It’s a function

of age, time horizon, investment

objectives and other factors. But it’s

also about becoming comfortable,

and mindful, of your level of risk

tolerance.”

Determining your risk profile can

be challenging – you may not know

how much you’re prepared to lose

until the market falls – but talking to

an advisor can help.

Once you’re comfortable with

your risk profile, you’ll have to build

a portfolio that suits your tolerance

level. This is the most important part

of the investment process, as studies

have found that more than 90

percent of a portfolio’s volatility and

risk is related to its asset mix, says

Cooke. If the asset mix is off, then

losses could be greater than what

you had anticipated.

LOWER YOUR RISKPROFILE WITH ETFsETFs are an ideal risk-management

tool for several reasons. First, they’re

instantly diversified, so you don’t

have to worry about one stock sink-

ing your portfolio. They can also be

bought and sold at any point during

the trading day, just like stocks,

which adds additional flexibility to

a portfolio, says Cooke. Most are

also highly liquid, transparent and

low-cost.

“They’re a very efficient asset-allo-

cation tool,” he says. “You can have

complete discretion when buying or

selling them, and you can see what

they hold. They can be effective for

diversification.”

You’ll likely want to start building

your portfolio with more traditional

index-tracking ETFs, such as a fund

that follows the S&P 500 or S&P/TSX

Composite Index.

But while owning a Canadian, U.S.

and international fund will give you

a diversified portfolio, holding only

traditional ETFs carries some risk.

For instance, a basic Canadian ETF

will be heavily weighted to energy

and financials.

“Investing in the stock market

broadly creates certain non-diversifi-

able risks,” says Cooke. “So, there is

some inherent risk in stock market

investing. What you can do, though,

is increase diversification in the port-

folio, but doing it so it’s still in line

with your own preferred asset mix.”

ADD SMART BETAOne way to increase diversification is

to incorporate smart beta ETFs into

your asset mix. These funds com-

bine active investing strategies, such

as value, dividend and momentum,

with a passive fund structure.

You’ll still get the same benefits as

you do with traditional ETFs – intra-

day trading, low fees and liquidity –

but you can now take advantage of a

more specific strategy. For instance, if

you prefer value companies, you can

purchase a smart beta product that

only holds value stocks. If you want

to add dividends to your portfolio,

you can buy an income-oriented

fund.

If you’re worried about being

overly exposed to two Canadian

sectors, then something like Macken-

zie’s Maximum Diversification Can-

ada Index ETF, which has a higher

weighting to consumer discretionary

and staples stocks than its passive

peers, could help reduce concentra-

tion risk, too, says Cooke.

INCORPORATE ACTIVE ETFSThose who want to mitigate risk

further may want to consider adding

active ETFs to their portfolio. Like

mutual funds, these securities hold

stocks chosen by managers, but they

trade in the same way as an ETF.

Mackenzie recently launched four

active ETFs, including one based

on its Mackenzie Ivy Team, which is

known for running high-conviction

portfolios of 20 to 25 stocks, and

one fixed-income ETF, with bonds

chosen by managers.

“By being actively managed, a

portfolio would include uncorrelated

assets,” says Cooke. “Managers can

find picks that can beat the market or

implement risk-mitigating strate-

gies.”

Clearly, there are many ways to

create a portfolio and take on as

much or as little risk as you want.

When it comes to risk management,

especially in today’s market, having

flexibility is key.

“The best practice for investors is

to use all these kinds of ETFs,” says

Cooke. “You can build better out-

comes by using the tools we have at

our disposal.”

REDUCING PORTFOLIO RISKWITH ETFsWith more innovative ETFs on the market, risk management has never been easier

SPONSOR CONTENT ADVERTISING FEATURE PRODUCED BY GLOBE CONTENT STUDIO. THE GLOBE’S EDITORIAL DEPARTMENT WAS NOT INVOLVED.

(ETFs) are a veryefficient asset

allocation tool. Youcan have completediscretion whenbuying or sellingthem and you cansee what they hold.

Michael CookeMackenzie’s head of ETFs

B10 G THE GLOBE AND MAIL | TUESDAY, FEBRUARY 13, 2018ETFS

For Canadian investors whoare into exchange-tradedfunds, the question now is

what to do about the bumpy ridein U.S. markets.

Is it better to strap in, hold onand ride, or should you diversifynow?

On one hand, the pullback inthe U.S. market could presentbuying opportunities. At thesame time, for a year or so, manyhave been expecting a U.S. mar-ket correction.

Yet in the face of these predic-tions, despite a few pullbackshere and there, U.S. markets con-tinue to show strength.

It’s not clear how close we maybe to the end, says Sean Cleary,finance professor at the SmithSchool of Business at Queen’sUniversity in Kingston. “There arelots of positives in the U.S. econo-my. The question is whetherthese positives have already beenfactored into the markets.”

Diversification is the way toprotect the gains you’ve made,”says Neville Joanes, chief invest-ment officer of WealthBar, a Van-couver-based robo-advisor thatoffers ETFs. Lots of investors arecautious and may be spooked bythis month’s correction. Thatdoesn’t necessarily mean it’s timeto run away from the UnitedStates, though, he says.

“ETF investors will still wantexposure to the U.S. and itsgrowth potential when makingan equity investment. Over halfof global equities are based there.However, investors will want toreduce the tracking of the cap-weighted index to lower volatil-ity,” he explains.

“To start with, investors mightlook at a fund like the VanguardTotal Stock Market ETF (VTI),which invests in a broad range ofU.S. equities, not just the S&P 500.That’s still all-in on equities,though, so a market correctionwould potentially hit them quitehard,” Mr. Joanes says.

“For an even higher level ofprotection, look to broader assetdiversification beyond what theretail investor would typicallybuy into. That might include realestate, high-yield bonds, mort-gages, REITs, preferred sharesand other investment strategies.”

Yves Rebetez, managing direc-tor and editor of ETF Insight, saysthat even if U.S. markets remainrobust and show little sign ofquitting, investors should alwaysprepare prudently for a 5- to 10-per-cent correction that couldoccur at any time.

One strategy is to look beyondthe United States, he says. “Inves-tors are and have been looking atpivoting more of their exposureto international and emergingmarkets, where valuations areless demanding,” Mr. Rebetezsays.

“Emerging markets alreadyhad a banner year in 2017, yetthere’s still room on the upsidefor valuations.”

Darren Coleman, senior vice-president and portfolio managerat Coleman Wealth, RaymondJames Ltd. in Toronto, suggeststhat investors look at ETFs thatpay dividends. “We’re big fans ofdividend investing. We’re mostinterested in ETFs that pursue adividend-growth strategy, as wecan hold that through marketcycles most effectively,” he says.

Mr. Coleman’s colleague, ana-lytics specialist Spencer Barnes,suggests looking at dividend-focused ETFs such as those in theWisdomTree Dividend Growthgroup.

“In the U.S., the ETF would beWisdomTree’s U.S. Quality Divi-dend Growth Fund [DGRW] ortheir variably hedged version,DQD [U.S. Quality DividendGrowth Variably Hedged IndexETF],” he says.

Navigating a down market canbe easy if you’re patient, Mr. Cole-man adds. “In my view, the port-folio shouldn’t materially changeunless the plan changes. If we’vebuilt a properly diversified invest-ment portfolio that is designed tohit our longer-term investmenttargets, then part of that con-struction process would have fac-tored in historical levels of volatil-ity,” he explains.

Mr. Coleman agrees: “The bestadvice I can give in a market cor-rection is: Don’t just do some-thing, stand there.”

Special to The Globe and Mail

What to doabout thechoppy ride?

Navigating volatilityrequires patience anda gut check of yourlong-term aims

DAVID ISRAELSON

Technology stocks havesurged over the past year,but the sector bears little re-

semblance to the speculative1990s dot-com era.

Larger companies flush withcash now pay dividends. Growthalso comes from smartphones,cloud computing and roboticsrather than the personal comput-ers and hardware of the past. Andexchange-traded funds (ETFs)have become more innovative,letting investors bet on tech nich-es instead of just the sector.

With the recent market pull-back now offering a better entrypoint, we asked three ETF watch-ers for their top picks.

DANIEL STRAUS, ETF ANALYST ATNATIONAL BANK FINANCIAL INC.

The pick: Horizons Robotics andAutomation ETF (ROBO)

This ETF invests in the growingrobotics and automation indus-try, whose products and serviceshelp firms boost productivity andincrease efficiency, says Mr.Straus. Their technologies areused in everything from search-and-rescue operations to farm-ing, surgery and warehouse logis-tics, he says.

The global equity ETF tracks 84firms and hedges its U.S.-dollarexposure back to Canadian dol-lars. iRobot Corp. and Daifuku Co.Ltd. are among the top holdings.A downturn in global manufac-turing, or a general economicslowdown in emerging marketsthat could cause demand forthese technologies to decline, is arisk to this ETF, he said. Launchedlast fall, the ETF is expected tocharge about an 0.85-per-cent fee,he says.

The pick: First Trust Dow JonesInternet ETF (FDN)

This fund is a play on Web-based companies that are still ahuge driver of future economicgrowth, says Mr. Straus. The ETF,launched in 2006, has exposureto the so-called “FANG” Internetstocks. Facebook Inc., Amazon-.com Inc., Netflix Inc. and Alpha-bet Inc. (formerly Google Inc.)make up 33 per cent of the 40-stock portfolio.

The ETF gained about 37 percent last year compared with 22

per cent for the S&P 500 Index.Because the FANG stocks havedriven “incredible performancefor the ETF and the market,” amajor pullback among theseheavily weighted names wouldhurt fund performance, he notes.The fund’s 0.54-per-cent fee isslightly cheaper than peersfocused on this niche, he adds.

DAVID KLETZ, ETF ANALYST ANDPORTFOLIO MANAGER,FORSTRONG GLOBAL ASSETMANAGEMENT INC.

The pick: ETFMG Prime CyberSecurity ETF (HACK)

This ETF, which gives exposureto the Internet security industry,should benefit from companiesand governments increasingbudgets to defend against poten-tial damage caused by cyberattacks, says Mr. Kletz. “Brandreputation is at stake as customerinformation has become a predo-minant target.”

The ETF tracks 45 cyber-secur-ity firms, including Science Appli-cations International Corp. andCisco Systems Inc. Because thisindustry tends to be “highly cycli-cal” as system upgrades can beaffected by cost-cutting duringeconomic downturns, that is arisk to the ETF, he notes. Thefund’s 0.60-per-cent fee is com-petitive versus other niche techofferings, he says.

The pick: iShares ExponentialTechnologies ETF (XT)

This fund is a diversified playon technologies that are highlyinnovative and potentially dis-ruptive to traditional businesses,says Mr. Kletz. The ETF invests innine themes globally, includingbig data analytics, robotics and3-D printing. Top holdings in-clude Bioverative Inc., Netflix Inc.and Tesla Inc.

The fund, which charges a 0.47-per-cent fee, is “one of the moreaffordably priced ETFs focusingon niche technologies,” he notes.

Because technology is a fast-mov-ing space, rapid obsolescence canultimately hurt profitability, hesays. Another risk is that valua-tions have become extended andcould reverse as more investorshave piled into the space, he adds.

Because of the progressivenature of the ETF’s holdings,there are risks, he says. As tech-nology is a fast-moving space,rapid obsolescence can make itdifficult for firms to monetizetheir ideas, while more spendingon research and developmentcould hurt profitability, he adds.

DENISE DAVIDS, ETF AND MUTUALFUND ANALYST AT INDUSTRIALALLIANCE SECURITIES INC.

The pick: VanEck Vectors Semi-conductor ETF (SMH)

This ETF focuses on the semi-conductor industry, which is driv-ing the proliferation in consumerelectronics, says Ms. Davids.Semiconductors, which are ma-terials that have electrical con-ductivity, can be found in every-thing from smartphones to com-puters. The auto industry, how-ever, also relies onsemiconductors to enhance fuelefficiency and safety, and the ma-terials play a key role in self-driv-ing vehicles, she adds.

The fund holds 25 stocks, in-cluding Intel Corp., Taiwan Semi-conductor Manufacturing Co.Ltd. and Nvidia Corp. The lack ofdiversification in this ETF is a riskshould the tech sector suffer adownturn, she cautions.

The ETF’s 0.35-per-cent fee isattractive relative to its peers, shesays.

The pick: Global X Robotics andArtificial Intelligence ETF (BOTZ)

This ETF gives exposure to thehigh-growth potential of therobotics and artificial intelligenceindustries, says Ms. Davids.“These areas have become in-creasingly attractive to compan-ies looking to innovate, lowercosts and enhance efficiencies.”

This global equity ETF is halfinvested in Japan and 27 per centin the United States. Holdings in-clude Yaskawa Electric Corp., Nvi-dia Corp. and Fanuc Corp.

While this fund can offerstrong upside potential – itreturned 58 per cent last year –there is risk from its highly con-centrated approach, she said. Thefund invests in only 29 compan-ies.

This ETF charges a 0.68-per-cent fee that is “not unreasonablegiven the niche market that itplays in,” she said.

Special to The Globe and Mail

Bet on high-growth techwith these niche ETFsThe recent marketpullback may offerentry points to thisfast-moving sector

SHIRLEY WON

A robot barista named‘Sawyer’ brews and servescoffee at a Tokyo café thismonth. The HorizonsRobotics and AutomationETF invests in the growingrobotics and automationindustry. KOJISASAHARA/AP

Tesla’s new electric semi truck. The firm is one of the holdings of the iShares Exponential Technologies ETF. ALEXANDRIA SAGE/REUTERS

The world’s largest technologyexchange-traded fund (ETF)recently clawed its way back toits record high from 18 yearsago.

The U.S.-listed TechnologySelect Sector SPDR ETF (XLK)last month climbed past itsMarch, 2000, peak of US$65.44a unit reached just before thedot-com bubble burst.

The ETF, which rose to nearlyUS$70 a unit before the recentmarket downturn, now tradesslightly below its former peak.

This fund, which has more

than US$19-billion in assets,tracks an index of 71 tech stocksin the S&P 500. Last year, itgained a robust 34 per cent, out-pacing the broader market’s 22-per-cent return. It was also thebest annual performance in adecade for the fund, whichcharges a 0.13-per-cent fee.

Launched in 1998, the ETF’stop holdings include AppleCorp., Microsoft Corp., FacebookInc. and Alphabet Inc. But inves-tors hoping to cash in on Ama-zon.com and Netflix Inc.’sgrowth stories won’t find these

two iconic names in XLK.It may come as a surprise to

some investors since the twofirms make up the top-perform-ing FANG quartet of Internetstocks (along with Facebook Inc.and Google parent AlphabetInc.). Instead, Amazon and Net-flix can be found in the Consum-er Discretionary Select SectorSPDR ETF or elsewhere, includ-ing a niche technology ETF. Itpays to look under the hood.

Shirley Won

Largest tech ETF trades near its record high

LARGEST TECH ETF TRADES NEAR ITS RECORD HIGH

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INSPIRED TO BUILD.

WHEREVER YOU’REHEADING, ARRIVE READY.

TUESDAY, FEBRUARY 13, 2018 | THE GLOBE AND MAIL G B11ETFS

We Canadians may loveour country, but weadore it a little too much

when it comes to investing.While our stock market makes

up about 3 per cent of global mar-kets, and our bond markets makeup even less of the bond uni-verse, Canadian securities on av-erage make up more than 75 percent of our portfolios, accordingto research by the exchange-trad-ed fund provider Vanguard.

But Canadians have plenty ofETF options to invest in globally,and the list is growing in numberand diversity, from ultra-low-costpassive strategies to active man-agement overlays to hedged andsector-specific approaches.

Here are a few recommenda-tions from experts.

BROAD-BASED SIMPLICITY

Kyle Prevost is a millennialinvestment educator and authorof the popular personal financeblog Young and Thrifty. He urgesinvestors seeking a simple, diver-sified strategy to consider low-cost, passive ETFs that track theperformance of global markets,excluding Canada.

For equities, try Vanguard’sFTSE Global All-Cap ex-CanadaETF (VXC) or iShares’ Core MSCIAll Country World ex-Canada ETF(XAW).

“You can debate back andforth between the two withregards to small differences inholdings and MER,” he says, add-ing their management expenseratios are 0.27 per cent and 0.20per cent, respectively. “But thebottom line is … both offer a very

easy way to instantly invest inthousands of companies from allaround the world.”

For fixed income, Mr. Prevostsays investors should try a comb-ination of two ETFs: Vanguard’sTotal Bond Market Index ETF(BND) and its Total InternationalBond ETF (BNDX).

The first provides access to theU.S. market – the largest in theworld – while the other offersexposure to global bond markets,excluding the U.S. (Canadianbonds make up about 5 per centof its holdings). Both are tradedon the New York stock exchange,which Mr. Prevost prefers overToronto stock exchange-listed of-ferings. Toronto-listed offeringsare generally currency hedged,he says, and he is “skeptical thatthe higher management costsand tracking error associatedwith currency-hedged ETFs makethem worth it.”

TO HEDGE OR NOT TO HEDGE

Currency often has a significantimpact on the returns for Cana-dians investing abroad. For thisreason, whether to hedge pre-sents a dilemma for many inves-tors, says Yves Rebetez, manag-

ing director and editor of ETFInsight in Oakville, Ont.

Consider investing in Europe.The euro is expected to streng-then against the U.S. dollar as itseconomy is forecast to improvewhile the United States is expect-ed to wallow in ongoing politicalturmoil caused by DonaldTrump’s administration. If youbuy a U.S.-listed European ETF, arising euro can be a boon for itsvalue based on currency alone asthe U.S. dollar weakens.

But the case could be differentfor ETFs listed in Canada tradingin Canadian dollars if, for exam-ple, oil recovers. Fortunately Ca-nadians can choose from plentyof low-cost ETFs, hedged or not.These include iShares MSCIEurope Investable Market Index(XEU, or XEH if hedged isdesired), and Vanguard’s FTSEDeveloped Europe All Cap (VE, orthe VEH for hedged version).

Another plus is that the man-agement cost of hedging is mini-mal.

“Once upon a time, currencyhedging used to cost an extra 15basis points,” Mr. Rebetez says.“In recent years, if you look at theofferings of iShares, Vanguardand so forth, you will see that youcan get unhedged without any

additional cost.”Some ETF providers also offer

dynamic currency managementETFs that aim to hedge to varyingdegrees depending on macroeco-nomic factors. Among theoptions is WisdomTree’s Dynam-ic Currency Hedged Europe Equi-ty Fund (DDEZ).

The MER is about twice thecost of conventional Europeanequity ETFs. This extra cost maynot be worth it if the currencystrategy proves wrong, Mr. Rebe-tez says. “The second you moveaway from [passive manage-ment] and strap on factors thatentail elements of active deci-sions, the potential is there todetract from returns relative tothe market.”

SPECIFICALLY SPEAKING

While broad-based global ETFsprovide diverse exposure, youcan also invest in sector-specificor geography-specific funds totake advantage of conditionsunique to certain regions or sec-tors. Portfolio manager TylerMordy, who is also president ofForstrong Global Asset Manage-ment, offers two selections.

While Canadians often have

plenty of exposure to banksthrough Canadian equity ETFs, amarket dominated by financials,the U.S. sector could be facing abright future as the Trump ad-ministration loosens regulations.One option here is FinancialSelect Sector SPDR ETF (XLF),which tracks “an index of S&P500 financial stocks, weighted bymarket cap,” Mr. Mordy says.

“Even if the congressionalDemocrats block specificchanges, such as Dodd-Frank[Wall Street Reform and Con-sumer Protection Act], the ad-ministration has room to weakenregulations simply by reinter-preting existing laws.”

While the upside is presum-ably higher profit in the short-term, one note of caution is thatthe existing rules aim to avoidthe market excesses that led tothe financial meltdown in 2008.If those regulations are pushedaside, one might ask whether an-other crash is in the making.

Investors seeking regions thatcould outperform can look toJapan. Once a nation of savers,more of its citizens are turning tothe stock market. “Contrary topopular belief, Japanese savershave never been wealthier, hav-ing a net worth that is doublewhat it was at the peak of the1980s bubble,” Mr. Mordy says.

The percentage of the popula-tion investing in its stock mar-kets remains low relative to otherdeveloped markets, but thiscould be interpreted as a trendwith lots of room to grow. To cap-ture this potential, Mr. Mordy rec-ommends the iShares MSCIJapan ETF (EWJ), tracking a mar-ket-cap-weighted index of rough-ly 85 per cent of all Japanesestocks.

Another plus: The Japaneseyen is “dramatically undervalued… the cheapest it has been in 32years,” so buying the ETF todaycould benefit from a currencytailwind if the yen rises, boostingthe total return.

Special to The Globe and Mail

Counter your home country biasTo diversify a portfoliobeyond Canada,consider funds thattrack global markets

JOEL SCHLESINGER

The Japanese yen is ‘dramatically undervalued,’ says Tyler Mordy of Forstrong Global Asset Management. Herecommends buying an ETF that tracks Japanese stocks. SHIZUO KAMBAYASHI/THE ASSOCIATED PRESS