The final decision in our ETF portfolio review is to add back a fund that we should not have sold last year
Cris Sholto Heaton Investment columnist
Investors need to be willing to change their mind, so this week I am going to make a U-turn. In the last issue, I looked at some choices to replace the UK small caps in our exchange-traded fund (ETF) portfolio, but ruled them out and said I was leaning towards specialised factor ETFs. Yet the more I looked at this, the less convinced I was that targeting value or momentum or yield would add anything useful for our strategy. I couldn’t duck the conclusion that I was trying to be too clever.
Instead, the best option seems to be an energy sector ETF – one of the options I dismissed before. Energy was in the portfolio until December, when we dropped it because the inflation protection it offered no longer seemed crucial. I noted last week that it was on my watchlist, but said I wasn’t convinced it was the right environment. Perhaps I was reluctant to admit that selling it had been a mistake! It’s certainly not ideal that we closed this position when it was lower than it is now (this shows the difficulties of market timing), but that shouldn’t affect our decision to buy again.
Value and diversification
Why energy? First, we are looking for an asset that offers value. Energy appears to do so: the MSCI World Energy is on a price/earnings ratio of about 11. With cyclical stocks, it’s risky to say that’s cheap. If energy prices slump due to falling demand (eg, a global slowdown) or a surge in supply (eg, an end to sanctions on Russia), so will earnings. Energy stocks are price takers, not price setters, and price takers should trade at cautious valuations. But it doesn’t look stretched. Oil prices are not high, even after the recent rally. And firms are handing back cash, rather than investing too much in new supply, which is a good for investors.
