‘50% chance of recession’ – 6 ETFs for quality and defence

Volatility is back! After a surprisingly positive start to 2023, March has served as a reminder that rapidly rising rates do have consequences.

In this case, it was the failure of three US banks. The failure of smaller banks is a relatively common occurrence in the US, but failures of this size are much rarer. More recently, Credit Suisse suffered a loss of confidence, causing the Swiss regulators to step in and arrange a takeover by UBS.

Following the recent bank issues, Betashares Chief Economist, David Bassanese, currently sees a 50% chance of recession over the next 12 months.

“Our most likely scenario is that the lagged impact of policy tightening over the past year, along with further modest tightening in the first half of 2023, soon leads to a notable slowing in global economic growth, such that the US in particular descends into outright recession,” Bassanese said.

In conditions like these, a focus on quality, defence, and patience can pay off for investors. With this in mind, here are six ETF investment ideas to consider in these volatile markets.

Quality shares could shine during economic uncertainty

Periods of heightened volatility can offer opportunities for long-term investors to buy assets at a discount. However, it’s important to have confidence that the underlying businesses have the resilience to survive any economic hardship unscathed.

As such, investors may be looking for companies that offer the potential for relatively resilient earnings tied to non-discretionary revenues.

DRUG Global Healthcare ETF – Currency Hedged offers exposure to the largest global healthcare companies, hedged into Australian dollars. The largest global healthcare companies are mostly pharmaceutical companies. These are often considered “defensive” by nature of having inelastic demand for their products, and can typically pass rising costs on to consumers. Eight of the top 10 holdings in DRUG are major pharmaceutical companies.

Despite the “defensive” nature of their earnings, healthcare companies also offer the potential for growth. Data from the OECD shows healthcare expenditure growth of 5% and 6% in 2020 and 2021 respectively, across the 20 OECD countries¹.

DRUG allows investors to maintain exposure to equities, while focusing on companies that might be better placed to survive any health scares the economy may face. Of course, any sector-specific investment exposure should only be considered as a part of a broader, diversified portfolio. Over the five years to 28 February 2023, DRUG returned 8.46% p.a.²

For more direct exposure to quality, Betashares offers two ETFs that provide exposure to a range of high-quality companies across various industries. The indices that these ETFs aim to track select companies based on ‘quality’ metrics such as high return on equity, low leverage, and earnings stability.

AQLT Australian Quality ETF aims to track an index (before fees and expenses) that comprises 40 high-quality Australian companies. The index that AQLT seeks to track has returned 8.24% p.a. over the five years to 28 February 2023, adjusted for the management costs of AQLT³.

QLTY Global Quality Leaders ETF aims to track an index (before fees and expenses) that comprises 150 global companies (ex-Australia) ranked by highest quality score. The index that QLTY seeks to track has returned 11.05% p.a. over the five years to 28 February 2023, adjusted for the management costs of QLTY⁴.

Bonds offer defence and income

When it comes to defence in a diversified portfolio, government bonds have traditionally played a key role.

Government bonds are often viewed as a ‘safe haven’ asset. Longer duration bonds in particular have tended to rally during times of significant equity market weakness. This was witnessed recently when US and Australian government bonds rallied as concerns about Credit Suisse and US regional banks plagued markets.

As at the time of writing⁵, market pricing suggests that rate cuts could be on the horizon. If markets are correct about this, and a US recession does occur, this could create favourable conditions for a rally in government bonds.

High-quality, long term government bonds may be well placed for these conditions. Long term government bonds are highly sensitive to expectations of changes in interest rates, meaning that even small changes in rates can create relatively large moves in the price of the bonds.

GGOV U.S. Treasury Bond 20+ Year ETF – Currency Hedged invests in high quality, long-dated US Treasury bonds. The addition of currency hedging also seeks to minimise investors’ exposure to fluctuations in the AUD/USD exchange rate. As at 23 March 2023, GGOV’s yield to maturity was 3.77% p.a.⁶

AGVT Australian Government Bond ETF offers exposure to a portfolio of high-quality bonds issued predominantly by Australian state and federal governments. High credit quality and the potential for attractive yield can make it a useful defensive exposure for those with a preference for investing locally. As at 23 March 2023, AGVT’s yield to maturity was 3.80% p.a.⁷

Cash for the patient investor

For those who are uncertain about the future direction of interest rates, there is another option – get ‘paid to wait’.

AAA Australian High Interest Cash ETF  invests only in deposit accounts held with selected banks in Australia.

While many banks advertise attractive rates on deposit accounts or term deposits, these often come with conditions that could include not making withdrawals, depositing a minimum amount each month, or reversion to a lower rate after a limited time. AAA is simple and convenient, and can be bought and sold like any share on the ASX, with access to the fund’s variable interest rate earned on its bank deposits (currently 3.7% p.a.⁸) available to all investors.

AAA has historically also reflected increases in the RBA cash rate quickly, and with monthly distributions, investors won’t have to wait long to get their hands on that income.

A time for careful investing

This year has already presented many unexpected challenges for investors. Some, such as a potential US-led global recession, are already obvious and firmly in the sights of investors. Others – such as the recent spate of US bank failures – can catch investors off guard, remaining obscured until the very last moment. For investors who have positioned their portfolios appropriately, the impact might not be quite so severe.

Betashares Capital Limited (ABN 78 139 566 868 AFSL 341181) (Betashares) is the issuer of the Betashares Funds. Before making an investment decision, read the relevant Product Disclosure Statement, available from this website (www.betashares.com.au) or by calling 1300 487 577, and consider whether the product is right for you. You may also wish to consider the relevant Target Market Determination, which sets out the class of consumers that comprise the target market for the Betashares Fund and is available at www.betashares.com.au/target-market-determinations. This information is general in nature and doesn’t take into account any person’s financial objectives, situation or needs. You should consider its appropriateness taking into account such factors and seek professional financial advice.

Footnotes:

1. Source: OECD Health Statistics
2. Past performance is not indicative of future performance of any index or ETF.
3. Past performance is not indicative of future performance of any index or ETF. Index performance is net of AQLT’s management fees and costs (0.35% p.a.). You cannot invest directly in an index.
4. Past performance is not indicative of future performance of any index or ETF. Index performance is net of QLTY’s management fees and costs (0.35% p.a.). You cannot invest directly in an index.
5. As at 20 March 2023.
6. The annualised total expected return of a bond if it is held to maturity, the bond does not default, and the coupons are reinvested at the yield to maturity (YTM). The fund’s YTM is the weighted average of its underlying bonds’ YTMs in their local currencies. Does not account for the impact of FX hedging costs where currency hedging applies. Yield will vary and may be lower at the time of investment. Does not take into account fund management fees and costs.
7. As at 23 March 2023.
8. As at 22 March 2023. Net of fund management fees and costs. Interest rate on the fund’s deposit accounts is variable and may be lower at time of investment.