Those who know me know that every Sunday, somewhere in North London, I’m standing on the touchline of a football (soccer) pitch, either smiling as my U11 youth team maintains a lead against its opponents, or furiously chewing gum and wondering how I can change the game. Recently, after two weeks of consecutive losses, as team coach, I decided to completely change the formation and positional play, a complete overhaul/180-degree shift in strategy. And I’m pleased to say that thus far, this has worked! We’re back to our winning ways, and more importantly my young players are smiling.
As I write this blog, my 2023 outlook feels somewhat similar to this time last year. While my ETF predictions for 2022 were mostly on point (see link), it certainly looks like 2023 will require a more tactical approach given what we encountered in 2022—and perhaps another complete overhaul in strategy!
We expect 2023 to be a bumpy year for financial markets globally. We think it will be a year for playing defence, optimising income and tactically looking for a weakening US dollar to potentially allocate to emerging markets (EM).
Therefore, my industry predictions are as follows.
- Multi-factor smart beta ETFs will attract more investor flows
My first prediction centres around this defensive play. As such, we believe multi-factor smart beta exchange-traded funds (ETFs), especially those focused on quality and income-generating strategies, should outperform their relative assets under management (AUM) growth from this year as the decade of “cheap” money and record-low interest rates has passed. The era of such easy monetary policy has certainly benefitted ETFs and index funds. In particular, market capitalisation-weighted schemes, which are often heavily overweight to growth stocks, turned out to be a good buy-and-hold strategy that saw solid annualised returns. Our new interest-rate environment, however, calls for a more tactical approach to asset allocation and equity market exposures. Hence, ETF investors may start looking favourably on alternative weighting schemes such as multi-factor smart beta ETFs, which consider stock fundamentals in addition to just the market capitalisation of a stock. We believe this is a strong growth area next year.
- Fixed income and dividend ETFs will be asset-gathering winners in 2023
Income, income, income—we all need income more than ever! With inflation still high and the cost of living impacting us all, consumers will likely be optimising bills to keep more of their cash to weather the uncertainty of 2023 (I’ve already renegotiated my broadband provider and cancelled cable television, to mention a few). It’s no different from an investment point of view. While achieving solid returns requires a more tactical approach, we believe that optimising yields and income will certainly feature heavily in portfolio construction next year. Hence, we believe global and regional dividend ETFs, especially those that also screen for quality and value from a fundamental stock-picking point of view, will gather good inflows in the year ahead.
I can’t talk about income and not consider fixed income in 2023. It will certainly feature heavily in investor portfolios as all eyes remain on the US Federal Reserve (Fed) for its eventual pivot. An expectation of falling rates in 2023 makes fixed income a very attractive asset class. And, we believe the asset class offers attractive yields at comparatively lower risk compared to recent years. Duration is key, and the importance of selecting fixed income assets that can balance income and risk makes investment-grade corporate bonds a worthy contender in the fixed income sphere, in our view. Additionally, incorporating these fundamentals with the continued tailwind supporting environmental, social and governance (ESG) investing makes euro green bonds another attractive potential consideration for 2023.
- Single-country emerging market equity ETFs will likely see accelerated AUM growth
After a challenging year, 2023 could mark a period of recovery for emerging markets. Valuations are currently cheap across EM equities and continue to offer value as expectations for easing inflation levels point to potential US dollar weakening amid a Fed pivot. Not all emerging market opportunities, however, offer the same upside potential. Selecting countries that are “US friendly” and can benefit from innovation-leading sectors, such as technology and health care, could pave the way. That, coupled with exposure to markets that can take manufacturing market share from China, appear attractive to us. As such, we favour South Korea, Taiwan and India over a broad allocation to EMs.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those offering potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets.
Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favour in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.
For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.
ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
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