As the innovation economy continues to drive performance in 2021, investors can look to exchange traded fund strategies to access new growth opportunities.
In the recent webcast, Breaking the Mold: Approaching Innovation as a Fundamental Factor, Brian Levitt, Global Market Strategist, Invesco, outlined the nascent economic recovery and the potential for a drawn out rebound.
“This new business cycle will likely play out every multiple years and that monetary policy will likely be accommodative for the foreseeable future,” Levitt said.
“It appears that the economy is poised to accelerate, and that fiscal and monetary policy will be increasingly supportive,” he added.
This new type of market environment is more supportive of the equity markets, but Levitt pointed out that investors do not appear to be well positioned for the new business cycle, noting that more money has gone into bond strategies and money markets than into equities.
Investors will find more opportunities to enhance their wealth in equity markets, especially with about 25% of bonds in the Bloomberg Barclays Global Aggregate Bond Index showing a negative yield.
“Yields from money markets to Treasuries to core bond strategies remain paltry,” Levitt said. “On the other hand, stocks have been trading cheap relative to bonds based a comparison of the earnings yield of the S&P 500 Index to the 10-year US Treasury rate.”
Nevertheless, income-focused investors may look beyond government-related strategies to seek additional income, including credit, equity income strategies, and specialty income asset classes. However, Levitt warned that the additional income may add undue risk.
Instead, Levitt argued that there is still a case to be made for equities to advance in the coming years. He underscored the fact that equity returns over the past 20 years are still muted and don’t reflect extreme returns. Stocks have been trading relatively cheap to bonds. The money supply has been expanded significantly, and equity valuations historically rise as the money supply increases. Additionally, investors are still not exuberant about equities. Flows data even shows that investors have largely been pulling money out of equity strategies for the better part of the past 10 years.
While there is a case to be made for equities, Levitt also warned that investors of the potential shortcomings of a traditional market cap-weighted indexing methodology, such as those that track the S&P 500 Index, which is highly concentrated in the top five companies in the index. The top five holdings of the S&P 500 make up 20% of the benchmark’s portfolio.
Alternatively, “broad market strategies that weight the portfolio based on different criterion than market capitalization, may outperform the S&P 500 Index over time, albeit with varying levels of volatility,” Levitt said.
Investors can target the size factor with funds like the Invesco S&P 500 Equal Weight ETF (RSP). RSP equally weights its holdings, so the ETF leans toward smaller companies or reduced concentration risk to the largest companies when compared to the cap-weighted benchmark S&P 500 Index. The size factor offers the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered. Smaller capitalization companies tend to have higher growth potential, and are less liquid widely researched.
“The equal-weight S&P 500 Index has tended to outperform the market-cap index in the aftermath of recessions,” Levitt said.
“In the recovery from the 2008 global financial crisis, small- and mid-cap equities were among the strong performers. Value stocks also performed well, as did growth stocks. Large-cap growth stocks rose to the fore once the economy moved beyond the recovery and into the expansion phase of the cycle,” he added.
Ryan McCormack, Factor & Core Equity Strategist, Invesco, explained that the equally weighted approach has the potential to generate outperformance and reduce concentration weight to largest stocks in economy. It seeks enhanced return potential while targeting similar risk/reward trade-off to S&P 500 Index and imposes strict “buy low/sell high” discipline through quarterly rebalancing.
McCormack also pointed to the popularly observed Invesco QQQ Trust (NASDAQ: QQQ), which tracks the Nasdaq-100, 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market, as a way to access some of the largest innovative companies in the U.S. markets.
QQQ offers access to a legacy of innovation and growth fueled by robust research and development, along with exposure to forward-thinking growth companies not held in the S&P 500. Underlying holdings include profitable growing companies with strong fundamentals. Their sales, earnings, and dividend growth rates significantly surpass that of the S&P 500 and Russell 1000 Growth Indices.
Investors looking for exposure to the next generation of innovative companies not yet listed by the Nasdaq may opt for the Invesco NASDAQ Next Gen 100 ETF (QQQJ). QQQJ extends the QQQ concept further by offering access to the ‘next 100’ non-financial companies listed on the Nasdaq outside of the NASDAQ-100 Index.