Capturing future growth will require a more targeted approach, says First Trust Canada's head of ETFs
The large-scale stimulus program, sparked by the pandemic-induced market crash in March 2020, pulled forward growth, pointing to leaner years ahead. However, one sector continues to present “opportunistic alpha” for advisors – e-commerce.
One of the big winners from the pandemic, the surge in online shopping is hardly breaking news. However, the numbers suggest that significant runway remains. Prior to the pandemic, online sales accounted for 11% of the total retail spending, having taken about a decade to get from 4% market share to 11%. During the pandemic this peaked around 16% (it’s retreated to 14%), representing a 5% jump in just five months.
Karl Cheong, head of ETFs at First Trust Canada, believes there remains significant upside potential despite bricks and mortar stores reopening. That's because, somewhat surprisingly to the uninitiated, online retail penetration has been relatively small. However, Cheong thinks that many of the habits formed during the pandemic will likely persist post-COVID, citing grocery shopping as a prime example.
Cheong said: “When advisors have conversations with their clients, they can see they like a lot of the trends [in e-commerce]. It's very conversational and we're seeing interest because expected growth rates are going to be lower going forward.
“What we've done as a government and as a central bank, we’ve pulled forward all the growth that we’re trying to monetize, so how are you going to get the growth to achieve clients objectives? E-commerce, cybersecurity and green energy – these are all the areas where we expect more spending, more penetration, more growth; you just need to target a more targeted approach."
First Trust captures this growth via a product that’s been in market for more than 15 years in the U.S. and which was recently brought to Canada – the First Trust Dow Jones Internet Index Fund (FDN), which seeks results that correspond generally to the price and yield, before fees and expenses, of the Dow Jones Internet Composite Index.
Having outperformed the S&P Technology and the S&P 500 indexes by hundreds of per cent over the past decade, the ETF focuses on future winners. And while the Dow Jones Internet index holdings currently represent more than 14% of the S&P 500 Index’s market cap, this wasn’t the case 15 years ago when the index holdings were just 0.8% of the index.
Cheong said that for much of the past 15 years, investors didn’t have much exposure to internet stocks by owning a fund linked to the S&P 500. First Trust believes thematic investing can, therefore, help investors gain exposure to the growth potential of tomorrow’s industry leaders, especially with forecasters suggesting that online retail penetration will be trending around 20% five years from now.
Cheong added that while valuations are important, they are not the only factor to consider because disruptive, high growth themes like the internet can remain “expensive” for long periods of time. As of June 30, 2006, the Dow Jones Internet Index Fund traded at 24x forward one-year earnings estimates, which may sound “cheap” today, but on that same day, the S&P 500 Index traded at just 16x forward one-year earnings estimates, making the Dow Jones Internet Index almost 50% more expensive.
While relative (and absolute) valuations have fluctuated significantly since 2006, on average the Dow has been approximately 54% more expensive than the S&P 500 Index. Looking back, the Dow Jones Internet Index was “cheaper” than the S&P 500 in just one out of the past 60 quarters. Cheong explained: “In other words, those that were waiting for a bargain to buy internet stocks probably never got in.”
The sector comes with volatility, however. While the ETF's annualized return is close to 20%, it’s had seven drawdowns greater than 20%. Investors who held it did great; those that tried to time it struggled.
Cheong added: “We’ve learned that it’s really difficult to time. If you want long-term growth, you have to hold it throughout the periods of volatility.”