Alpha Generating Opportunities using Single Country ETFs

In portfolio construction, it is critical to consider the correlation between different asset classes. By combining uncorrelated assets, the movements of one asset can be offset by the movements of another, thereby reducing volatility in a portfolio. Usually, the three main asset classes in a portfolio are cash, fixed income and equities. But in many modern portfolios, other asset classes such as real estate, commodities, private equity, and alternatives can be found. Fixed income and equities have also been broken down further given the wide range of factors resulting in substantial dispersion of returns.

Another option to enhance portfolio diversification is searching for opportunities outside of developed markets. It’s a common misconception that adding developing and emerging markets to a portfolio increases risk. Economies outside of Canada and the U.S. are not perfectly correlated, and this can reduce volatility over the long-term and provide alpha generating potential.

Analyzing the returns of emerging markets in 2021, there was dispersion of over 55% between different countries (see Exhibit 1). The best performing emerging market was Saudi Arabia, while the worst was China. China struggled with significant government policy changes, while Saudi Arabia saw unprecedented gains due to the strong oil market, a wave of new IPOs, higher dividends, and the positive financial results of many of its companies.

In 2020, the South Korean market not only outperformed the Asian region, but also most developed nations around the world. Higher inflation and supply chain issues then caused South Korea to lag in 2021 (see Exhibit 2). It’s clear that country returns can be volatile, but this provides significant opportunity for alpha generation.

There are various factors that influence the returns of a particular economy. These include inflation, exchange rates, interest rates, economic growth, trade balance, public debt, the labor market, corporate profits, political stability, government policy, etc. Given the wide range of variables that can affect the dispersion of returns for different countries, investors looking to boost international exposure may consider targeting single countries.

This can be achieved through using single country ETFs that provide targeted exposure to specific nations. Investors can use these ETF to amplify international exposure for either tactical or strategic positions in a portfolio.

Franklin Templeton’s suite of passive equity single country and regional ETFs track the market capitalization weighted indexes developed by FTSE Russell. These are among the lowest cost single country ETFs on the market and can help investors build precise international portfolios, tactically execute global investment themes, and amplify existing broad market strategic positioning. They also provide passive beta exposure and can be traded intraday either long or short in an extremely cost-effective manner.

In 2022, there are many factors for investors to consider, as our Head of Global Index Portfolio Management, Dina Ting, wrote in her recent paper. Geopolitical, economic and social issues should be taken into consideration, as well as the complexities of the pandemic. Markets are constantly shifting, so disaggregating international exposure can help to manage risk and return, while adding the ability to pinpoint specific exposures. High return dispersion among countries and the varying factors driving country performance make a strong case for using single country allocations, and ETFs are a cost-effective tool for investors to gain precise exposure based on their convictions.

Bobby Eng’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinion, and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.