A fund manager I know performs an interesting task with his team as June 30 approaches each year. They look at the market’s worst-performing sectors and stocks for the past financial year and ask: would they buy them today?

The goal is understanding why the market is so bearish on these stocks, if the pessimism has gone too far, and if opportunities have emerged.

It’s a variation on the Dogs of the Dow, a popular stock-picking theory in the US that involves buying the 10 worst-performing stocks in a key index, provided they pay a dividend. The goal: finding treasure among market rubbish.

I, too, do this exercise at the end of calendar and financial years. Partly because my investment style is to hunt for out-of-favour sectors and stocks, and also because it’s harder to find stocks to buy now in a slightly overvalued market.

As I write this column, the US equity markets are near record highs. Back home, the S&P/ASX 200 Index just shy of its record high. Japan’s Nikkei 225 Index is a whisker below its record high, such is the investor euphoria.

Experience shows that when the global equities market is rallying like this – and, more importantly, when many stocks are trading above fair value – it pays to take some money off the table by increasing portfolio cash allocations.

Granted, investors might miss a few profits as the market rally continues. But investing based on market momentum rather than company fundamentals and valuations is rarely a good idea for long-term portfolio investors.

To be clear, the Australian equities market is not excessively overvalued. The Morningstar Fair Value Estimates suggest the market is trading just above fair value. Also true is that fear last month that rates could increase a few times this year, after a hot inflation number, is dissipating. Latest data showing Australia’s economy is cooling has swung the pendulum back to rate cuts this year, although I expect rates will remain on hold this year.

My core view, however, remains with key equity markets near record highs, it’s prudent to take some money off the table to free up cash to reinvest at better valuations in the next few months. That is, to watch and wait for better value.

That view can seem unpopular, or downright wrong, when markets are hurtling higher and greed kicks in. Nobody wants to get off when the bulls take charge. To be clear, it’s not about exiting, just lightening a few positions to free-up cash.

Some keen judges I know are doing just that right now. Like me, they think the market has run a touch ahead of itself, given uncertainty about inflation and interest rates and the risk of a larger economic slowdown.

For those who want to put that cash or new money to work, it pays to look at sectors and stocks left behind in the rally.

Worst-performing ETFs

That brings me back to the worst-performing sectors and using that as a basis to find opportunity. For this column, I crunched the numbers on the market’s 10 worst-performing Exchange Traded Funds (ETFs) over 12 months to end-April 2024, by re-sorting data from the excellent ASX Investment Products Monthly Report. The losses show an investment bloodbath.

The 10 worst-performing ETFs over that period were:

Two things stand out from that list. First, the large number of renewables and green-energy ETFs, which shows how out-of-favour clean-energy investing has become in the past few years.

Second, the danger of betting against the US equities market and the US dollar in the past 12 months. Betting on a fall in US equities through the BetaShares US Equities Strong Bear Currency Hedge was a disaster, particularly as that ETF provides leveraged exposure that magnifies losses and gains.

So, which out-of-favour ETFs would I consider now? Here are two from the renewables sector. Clean-energy stocks, on average, have burnt investors in the past few years.

With US equity indices at record highs, I suspect more fund managers will pay more attention this June to sectors left behind, as they rotate some profits into badly out-of-favour stocks with long-term tailwinds.

1. BetaShares Solar ETF (ASX: TANN)

After a strong 2020, renewable energy stocks have mostly been smashed due to rising interest rates, earning disappointments and more nations prioritising energy security, through fossil fuel projects, after Russia’s war with Ukraine.

The MAC Global Solar Energy Index, a key barometer of global solar stocks, is down almost 40% over 12 months. It’s off almost 20% year-to-date.

Beneath those losses is a global solar industry that operationally had a record year, while the global renewable energy sector attracted record investment. Prospective investors will need patience and a high risk tolerance, but solar is critical to the world’s clean-energy transition and decarbonisation.

The BetaShares Solar ETF provides exposure to the world’s leading solar-energy companies in a single trade via ASX. It’s the market’s worst-performing ETF over one year to end-April 2024 with a 35% fall, in a sector that arguably has some of the best long-term prospects as solar energy continues to grow.

TANN’s annual management fee is 0.69%.

Chart 1: BetaShares Solar ETF

Source: Google Finance

2. VanEck Clean Global Clean Energy ETF (CLNE)

Investors seeking more diversified exposure to the clean-energy sector could consider the VanEck Clean Global Clean Energy ETF, an index fund I have written about this year.

To recap, CLNE provides exposure to 30 of the largest global companies involved in clean-energy production, technology, and equipment.

CLNE’s top-10 holdings include some of the world’s best-known solar and wind-power companies, such as NEXTracker Inc, Enphase Energy Inc, Meridian Energy and First Solar.

CLNE returned -26% over one year to end-April 2024, ASX data shows. After heavy falls, average valuation metrics for stocks in CLNE look reasonable. As with the BetaShares Solar ETF, patience will be needed to wait for a recovery.

As I’ve previously noted, CLNE is concentrated by ETF standards with only 30 stocks in its portfolio. Conservative investors might prefer a more diversified ETF. CLNE’s annual fee is 0.65%.

Chart 2: VanEck Clean Global Clean Energy ETF

Source: Google Finance

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation, or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation, and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 22 May 2024.