Lessons from the March meltdown

Real estate investment trusts (REITs) are normally less volatile than the broad market, thanks in part to regular above-average distributions. Since they are interest-sensitive, they benefit from a low-rate environment. But they’re also economically sensitive. The pandemic has sparked fears of a recession or worse that would cause large numbers of both commercial and residential tenants to default on rents or terminate leases.

As a result, most REIT ETFs had steeper losses than the broad equity market in March. The biggest loser, Vanguard FTSE Canadian Capped REIT Index ETF, was down 29.2%. Middlefield REIT Indexplus ETF, down 16.4%, was the only REIT ETF whose one-month loss was less than the market as a whole — and not by much.

Another disappointing income-oriented equity type was preferred shares. Though they are equities, preferreds are often considered a type of fixed-income because their dividends are more secure than common dividends in the event of corporate financial distress.

Even so, preferreds proved to be no haven in March, as investors shunned any type of credit risk. Losses among ETFs that invest primarily in Canadian preferreds ranged from 25.4% for Lysander-Slater Preferred Share ActivETF to 16.7% for CI First Asset Preferred Share ETF.

Worse still for income-oriented investors was the plunge in the corporate bond market, affecting even the most credit-worthy issues. This ran counter to the notion that high-quality bonds protect capital when equity markets collapse.

In March, Government of Canada issues held up reasonably well, while long-term U.S. Treasury bond ETFs had robust returns of 9% or more. But corporate bond prices sank as yield spreads widened alarmingly. Exemplifying the performance gap was iShares Canadian Corporate Bond Index ETF, down 7.3% in March, while iShares Canadian Government Bond Index ETF lost only 0.6%. Making matters worse, lack of liquidity in the corporate market resulted in ETFs trading temporarily at discounts to their net asset value.

The lower the credit quality, the greater the fixed-income losses, many of which were in double-digit territory. At the bottom of the heap was Horizons Active High Yield Bond ETF, down 24.5%. Also incurring heavy losses were floating-rate ETFs, whose portfolios are less credit-worthy than those of fixed-income ETFs in core categories. Worst hit was Purpose Floating Rate Income Fund, down 19.1%.

In the broad Canadian equity category, one-month losses exceeded 20% for more than a dozen ETFs, with the median loss of 17.7% matching that of iShares Core S&P/TSX Capped Composite Index ETF. Strategies that aim for below-market volatility or employ quality screens mostly fared better. The narrowest loss, 11.1%, was that of Franklin Liberty Risk Managed Canadian Equity ETF, whose managers at Calgary-based Franklin Bissett Investment Management employ a multi-factor methodology with growth, value, low volatility and momentum as key criteria.

For investors in U.S. equity ETFs, the most popular foreign category, diversifying outside Canada paid off in March. ETFs invested in the world’s largest stock market had mostly smaller losses than their Canadian counterparts, due in part to the outperforming technology sector and less exposure to plunging energy stocks. The tech-heavy BMO NASDAQ 100 Equity Index ETF lost only 1.1%. Other outperformers within the U.S. equity category included quantitative strategies that employ low-volatility or quality-factor methodologies. The only positive return was the 1.1% earned by BMO Premium Yield ETF, which screens large-cap U.S. stocks for quality, yield and liquidity, and engages in option writing to generate income.

A key performance differentiator for U.S. equity ETFs is whether they are currency-hedged. With the U.S. dollar appreciating during the month, the edge went to non-hedged funds. For example, Vanguard S&P 500 Index ETF lost 8.7%, much less than its counterpart Vanguard S&P 500 Index ETF (CAD-hedged), which was down 13%. What some Canadians might view as currency risk turned out to be a good source of diversification.

As would be expected, the worst- and best-performing equity ETFs were those with sector-specific mandates. The hardest hit were energy-sector funds, which even before the pandemic were reeling from a global price war that had resulted in plunging oil prices.

Among the casualties was iShares S&P/TSX Capped Energy Index ETF, down 46.8% in March. Excluding leveraged ETFs, the biggest March loser of any Canadian-listed ETF was BMO Junior Oil Index ETF, down 53.8%, mirroring the woes of Western Canada’s most vulnerable companies. On the bright side, bullion ETFs had positive single-digit returns, reflecting gold’s traditional role as a store of value.

Overall in the equity categories, fewer than a dozen ETFs eked out positive returns. Heading the list were two of Evolve Funds Group Inc.’s specialty funds. Evolve Cyber Security Index Fund returned 2.1%, and Evolve E-Gaming Index ETF, apparently benefiting from stay-at-home emergency orders, gained 1.5%. Not all was rosy for the Toronto-based firm’s specialty lineup; Evolve U.S. Marijuana ETF got smoked, losing 30.7%.

Elsewhere, most alternative strategies ETFs either lost money or did little more than break even in March. The notable standout was AGFiQ US Market Neutral Anti-Beta CAD-Hedged ETF, designed to hedge against falling markets. This ETF gained 10.3% in March, fulfilling its mandate as bear repellent.