With five-decade-high concentration in equities and earnings beats continuing to defy the uncertain outlook for inflation and growth, it is time for investors to get familiar with the defensive positions offered within ETFs.
The mood music for a toppy market intensified last week as JP Morgan Private Bank described valuations as “priced for perfection”, with the risk-reward balance now negatively skewed after more than a year of upside for equities.
“Investor optimism is high as a better-than-goldilocks outcome has become consensus, and positioning is elevated with several indicators pointing to overbought conditions,” JP Morgan said.
“Markets are priced for perfection as valuations are rich, and extreme crowding in momentum stocks risks a sharp correction in this factor.”
Nowhere does this story resonate more clearly than in the US, where equity concentration is at a level not seen since the 1970s, with the ‘magnificent seven’ accounting for around two-thirds of S&P 500 gains last year – with each of its members gaining an average of 111%.
The first quarter of 2024 has greeted investors with stubborn inflation, stratospheric Q4 earnings from the likes of Nvidia and a far more hawkish policy stance from central banks. Amid an uncertain backdrop, ETF Stream selects five ETFs to diversify and derisk portfolios away from narrow US equity leadership.
1. Xtrackers MSCI World ex USA UCITS ETF (EXUS)
A first building block to this end is the newly launched EXUS, which is listed on the Deutsche Boerse and London Stock Exchange (LSE) with a total expense ratio (TER) of 0.15% and claims the mantle of Europe’s first global equity ETF excluding US exposure.
The product physically replicates the MSCI World ex USA index of 870 large and mid-cap companies, comprising approximately 85% of the free float of 22 developed markets.
Despite containing the ‘MSCI World’ moniker, the ex-US benchmark is far removed from its parent index, which currently weights 70% of its basket to US equities.
Filling the gap left by the world’s largest equity market, the index’s three largest country allocations are Japan at 21.1%, the UK at 12.9% and France at 10.8%.
EXUS tops our list not as a world-beating ETF but as a tool for portfolio construction. While the MSCI World ex USA index lagged its parent benchmark by 87% between the turn of the millennium and November last year, removing US equities from a broad index exposure enables investors to be more selective in picking their moments within that market.
2. iShares iBonds Dec 2025 Term $ Treasury UCITS ETF (IT25)
On the fixed income side, ETF Stream revealed BlackRock’s IT25 listed on the Deutsche Boerse, LSE, Euronext Paris, SIX Swiss Exchange, Bolsa Institucional de Valores and Santiago Stock Exchange last September with a TER of 0.10%, providing the first target maturity US Treasury ETF in Europe.
The ETF employs a sampling methodology to physically replicate the ICE 2025 Maturity US Treasury UCITS index of 49 US sovereign issuances with an effective duration of 1.25 years.
While some fund selectors started adding duration at the end of last year, with a view to locking in higher yields for longer, higher-than-expected US core price inflation (CPI) prints to begin 2024 has refreshed investor wariness about creeping too far along the curve.
IT25 provides investors with targeted exposure to shorter-dated US Treasuries, reducing duration risk while locking in higher yields – with a current weighted average yield to maturity of 5.11%.
The ETF also sits between BlackRock’s conventional 0-1 year and 1-3 year Treasury ETFs in terms of yield and duration – with the latter at 0.32 years and 1.85 years, respectively.
The edge IT25 offers is the ability to lock in current yields until near maturity, whereas conventional bond ETF benchmarks will continue rebalancing their underlying to maintain target maturity, agnostic to yield.
3. VanEck Morningstar US Wide Moat UCITS ETF (MOTU)
Examining the toolbox for segmenting US equities, ETF Stream revealed VanEck brought its $13bn US wide moat strategy to Europe with a fee of 0.46% in January.
MOTU physically tracks the Morningstar Wide Moat Focus index, which is a ‘semi-active’ approach capturing 50 US stocks identified as having an ‘economic moat’.
The moat concept, first coined by Warren Buffett, describes companies which have a competitive advantage and is implemented by Morningstar through quantitative valuation metrics and identifying companies benefitting from cost leadership, economies of scale, network effects and intangible assets, such as brand strength and high switching costs for users.
In practice, MOTU’s alternative approach to quasi-quality factor exposure is interesting from a use case and portfolio construction perspective.
On the one hand, one might expect the ETF’s focus on strategically well-positioned companies to give it defensive qualities during periods of downturn.
In fact, Morningstar noted its wide moat index outperformed its broad US benchmark by 327 basis points (bps) annually since launching in February 2007 while also beating the broad index during decline years in 2008, 2018 and 2022.
Crucially, MOTU also has little exposure to current US equity giants, awarding its top weightings to Salesforce, Equifax, Masco, Wells Fargo and Walt Disney.
4. Xtrackers S&P 500 Equal Weight UCITS ETF (XDEW)
A recent posterchild for capturing US equities while avoiding sizeable mega cap tech allocations has been Europe’s largest equal-weight ETF, XDEW.
XDEW tracks the S&P 500 Equal Weight index, which equally weights all constituents of the headline US large and mid-cap benchmark at each rebalance date.
In practice, the ETF overweights mid-cap names and ‘old economy’ sectors versus its parent index, as underlined by the weight of the information technology sector cut to 13.3%, down from 29.8% in the vanilla S&P 500.
Much like EXUS, XDEW may outperform its conventional equivalent strategies through certain periods, however, its main use case in the context of managing overexuberance is portfolio construction.
Namely, XDEW enables investors to continue expressing conviction in US equities broadly without adding large positions to already lofty weightings in mega cap tech.
This approach proved popular through 2023, with XDEW turning $657m outflows through the first five months of the year into $2bn inflows by the end of the year.
5. Invesco Health Care S&P US Sector UCITS ETF (XLVS)
Finally, those seeking a classic defensive sector allocation within their US equity bucket could opt for Invesco’s XLVS, Europe’s lowest fee capturing the US healthcare sector with a TER of 0.14%.
XLVS synthetically replicates the S&P Select Sector Capped 20% Health Care index of 64 S&P 500 constituents classified as being involved in the healthcare sector in the Global Industry Classification Standard Global Classification Standard (GICS).
Fund selectors have preferred the healthcare sector as a defensive allocation during periods of valuation volatility, given the industry’s relative earnings stability and disconnectedness to economic cycles.
XLVS captures the sector while ensuring investors are not taking large single stock bets, with the 20% capping methodology of its benchmark.
