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.
Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.