11 high growth ETFs to tip the odds in your favour

Nearly all the value created on the US stock market since 1926 can be attributed to roughly 4% of listed companies. That was a key finding from a 2017 research paper by Hendrik Bessembinder published in the Journal of Financial Economics.

The findings present investors with a number of considerations. The odds of picking the winners are slim but the returns (if you do pick them) are highly attractive. Bessembinder also found that the out-performers also shared some common characteristics: high sales growth, strong reinvestment rates and large addressable markets.

In simple terms, identifying companies that possess these traits is what lies at the heart of growth investing. Whether you’re an advocate of actively managed or index tracking strategies the objectives are similar – invest in companies with higher than average earnings growth over long periods of time to generate above average returns.

It all sounds pretty good but growth investing also comes with challenges. Not least of which is that reality that the odds of picking a winner are heavily skewed against you. In addition, the volatility that comes with growth investing is a major hurdle. History has shown that investors routinely struggle to hold their nerves through bouts of volatility, selling out after a drawdown and failing to participate in the recovery.

To learn how you can tip the odds in your favour, I spoke with Michael Wayne from Medallion Financial and Cameron Gleeson from Betashares about the strategies and ETFs investors can use to build a high growth portfolio.

The discussion covers growth investing fundamentals, core and satellite opportunities and the case for gearing in a growth portfolio.

What you need to know about growth investing

It should come as no surprise that growth companies are sought after and therefore typically trade at higher valuations. Investors are backing these companies to maintain their earnings growth for many years and as a result they tend to trade at a premium to the market.

“When we think about growth stocks, ideally they’re going to grow those earnings over time, and that can mean that they’re susceptible to selloffs or pressure based on those higher earnings multiples,” explained Gleeson.

Volatility comes with the territory and time is a growth investor’s friend. If you have a longer time horizon you are better placed to withstand the ebbs and flows of the market.

Medallion’s Michael Wayne says one technique investors can use to combat volatility is to build exposure to a growth opportunity over a period of time or ‘average in.’

While investors often separate growth and income as separate strategies Wayne argues that income can be a welcome byproduct of adopting a growth mindset.

“Often people look to break markets down into growth and income, but ultimately if your company is growing quickly and earnings are growing quickly and free cash flows are growing quickly, then over time your income and the dividends that you’re receiving are growing quickly too,” he said.

That might be the case but if your focus is purely on income and capital stability then growth investing is unlikely to meet your objectives.

Why small caps and equal weight indices are back on the radar

When using growth as part of your core strategy Gleeson says diversification remains a key ingredient. Having exposure to a diverse range of profitable companies with stable earnings will provide a level of resilience to your portfolio.

Explainer: A ‘core holding’ forms part of the foundation of an investment portfolio offering reliable returns and diversification.

The NASDAQ 100 ETF (ASX: NDQ) is a widely used core growth exposure according to Gleeson. The Nasdaq is known for its exposure to the US technology sector, however, the earnings are diversified due to the global nature of these businesses.

For investors looking for a broader exposure beyond just technology, Gleeson says the S&P 500 Equal Weight ETF (ASX: QUS) has been popular with investors looking to take advantage of a broadening out of the US equity market performance.

“The S&P 500 Equal Weight Index is essentially the same 500 companies as the normal market cap weighted S&P 500, but rather than weighting them by their size, which would have around about 32% of that total index in the Magnificent Seven, you weight them equally. So 0.2% in every stock on rebalance. It’s a more broad representation of the US economy based on that sector mix,” Gleeson told Livewire.

This idea of broadening exposure has also caught Wayne’s attention, in particular he is drawn to the small cap end of the US market. Small caps have underperformed for an extended period, and Wayne has conviction that there’ll be a reversion to the mean and small caps will close the gap with large cap companies.

To get exposure to this opportunity Wayne is investing in the Pacer US Small Cap Cash Cows 100 ETF (BATS:CALF), which applies a quality filter to select only stocks that meet criteria such as return on equity and earnings reliability.

“Often there’s a lot of poorer quality businesses that don’t really have a pathway to earnings growth. So if you can apply some sort of filter then that makes sense,” he explained.

Satellite plays: China tech, small caps, and cybersecurity

For those comfortable taking on some additional risk in search of returns, having a small allocation to ‘satellite’ opportunities is a common strategy. This approach typically involves allocating a small amount of capital outside of your core portfolio.

Explainer: A ‘satellite holding’ refers to a smaller portfolio position targeting a specific investment opportunity with the objective of enhancing returns.

Chinese technology stocks have caught a bid following an extended period on the sidelines. It’s a cyclical opportunity Michael Wayne has been adding to portfolios via the Betashares Asia Technology Tigers ETF (ASX: ASIA).

“Chinese technology is trading really cheap at the moment. That ETF has a PE ratio of 15, which is almost incredible compared to US tech. So that’s a really good one that you can look to invest in, albeit maybe you’ve got to watch it a bit more closely over time,” he said.

Whilst the focus is on growth, satellite investments can bring an added benefit of greater diversification. Asian technology stocks have a limited overlap with the companies in a typical core portfolio.

“Asian tech tigers – that’s very lowly correlated to core equity exposure. So you can add a growth exposure there that can actually help you with diversification while giving you the potential for upside,” adds Gleeson.

A more thematic-driven opportunity is related to growing demand for cybersecurity globally. Gleeson says this is a long-term structural growth play that is reasonably defensive given the need for companies to continually invest in their capabilities to protect against cybercrime.

The Betashares Global Cybersecurity ETF (ASX: HACK) has returned 18.78% p.a. since its inception in 2016 and Gleeson is expecting further growth in this industry.

“We run this ETF and we know how much M&A activity there is in this space. Typically, when companies are bought up, they’re bought up at a premium. So we expect strong capital growth there over time,” he said.

The ‘sweet spot’ for growth on the ASX

The Australian market is typically viewed as low growth given the heavy representation of banks and miners within the ASX 200. Earnings growth for the major banks is flat and the cyclical nature of the mining industry makes earnings unpredictable and volatile. 

Financials and materials account for nearly 50% of the ASX 200 – explaining the low growth perception of the Australian market. Beneath the surface, however, the ASX is home to some high-quality companies that have delivered strong returns.

“If you look at the ASX performance over the last 20 years since 2000, and you split it into the ASX 50, ASX small caps, and ASX mid caps, the S&P ASX MidCap 50 Index has been by far the superior index. It’s delivered significantly greater returns,” explained Wayne. 

The S&P/ASX All Technology Index comprises of companies including Computershare (ASX:CPU), Xero (ASX:XRO), ProMedicus (ASX:PME), Carsales (ASX:CAR) and REA Group (ASX:REA). While investors often turn to the US for technology exposure this index offers exposure to market segments including information technology, consumer electronics, online retail and medical technology.

Wayne says these companies fit the category of quality compounders that can consistently deliver double digit earnings growth, albeit the journey for investors can be volatile.

“We think over the long term, something like an ASX: ATEC can continue to give you pretty good exposure to what we classify traditional quality compounders.”

Over the past six months Gleeson says one of the biggest concerns facing investors has been  portfolio decisions relating to expensive banks and miners with falling earnings. The Australian Quality ETF (ASX: AQLT) filters the largest companies based on their profitability, stability of earnings and balance sheet strength. Top 10 holdings include traditional large caps, like Commonwealth Bank (ASX:CBA), but at lower weights compared to the ASX200.

It also includes exposure to high-quality mid cap stocks with companies like Technology One (ASX:TNE), Breville Group (ASX:BRG) and Netwealth (ASX:NWL) offering exposure to higher growth companies on the ASX.

“I think AQLT and that allocation to both mid caps, which are going to be high quality mid caps as well as some allocation to the largest companies, will stand you in good stead throughout the market cycle,” Gleeson said.

The role of leverage in a growth-focused portfolio

While gearing isn’t as widely discussed as it was pre-GFC, it remains a tool for investors with long-term horizons. Gleeson explains that using a moderate level of gearing can help compound wealth over time, with less volatility than traditional high-gearing approaches.

Betashares’ Wealth Builder ETFs, such as its Diversified All Growth Geared (30-40% LVR) Complex ETF (ASX: GHHF), use internal gearing of around 30-40% and avoid margin calls, making them a simple, low-cost option for adding leverage.

The key? Keeping borrowing costs low. With interest rates currently below 5%, the hurdle for outperformance is manageable.

“If you are someone starting on your investment journey, or even if you’re a bit later on, you want to take advantage of the market’s compounding power, you want to do it in the lowest-cost way possible,” explained Gleeson.

We think adopting a smaller level of leverage is really going to help you in periods when markets are performing well, as well as when they’re perhaps not so jubilant.” 

Wayne agrees that gearing can make sense, especially for investors who believe markets tend to deliver strong returns over decades. But he cautions that leveraged products magnify both gains and losses, making them unsuitable for some investors.

For those who can stomach the volatility, more aggressive products like the geared Australian and US equity ETFs – ASX: GEAR , ASX: GGUS, or ASX: LNAS – can be used tactically after significant market pullbacks.

Gleeson adds that highly geared ETFs are often better suited to shorter-term trading, while lower-geared options can be part of a long-term growth strategy.