ETF Tendencies To Watch In 2023: Energetic Munis, World Attraction, And Dividend Funds
By David Mann, Head of World ETF Product and Capital Markets, Franklin Templeton
With January being a month for prognostications, David Mann, Head of World Change-Traded Funds (ETFs) Product and Capital Markets, shares his annual outlook for the ETF business and key traits he sees taking form in 2023.
First, I hope everybody had an exquisite New Yr and was capable of finding time to recharge their batteries. I don’t wish to go too far off-topic – given that is an ETF e-newsletter – however I do surprise typically if vacationing with the youngsters qualifies as a calming break from the conventional day by day grind.
That is my seventh (!) 12 months of giving ETF-related predictions. Final 12 months’s predictions had been disappointing from an accuracy perspective, and I suppose I must be grateful to my good associates on the Franklin Templeton grading committee for kindly giving me a D- fairly than flunking me for my disastrous environmental, social and governance (ESG) ETF name. I reread all six prior columns and suppose I’ve a good sense of which themes I ought to deal with for higher success in 2023. As all the time, that is an ETF predictions column, so there can be no market calls on rates of interest or S&P 500 Index end-of-year ranges.
- Energetic muni funds would be the lively fixed-income ETF story of the 12 months
I’ve mentioned lively ETFs quite a few occasions over the lifetime of this text, together with my 2021 predictions column written on the again of the passage of the ETF rule. Energetic fixed-income ETFs enable portfolio managers to remain nimble and keep away from sectors and elements of the credit score spectrum which may encounter elevated stress, all whereas leveraging the identical creation/redemption operational efficiencies utilized by index funds. That truth most actually applies to municipal bond ETFs.
Final 12 months was a captivating one for municipal bond funds, which have not too long ago been the subject du jour in each media and dealer/supplier analysis studies. The asset class felt related ache as different fixed-income exposures, so it was no shock to seek out important outflows in 2022. Nonetheless, inside these outflows there was a captivating sub-narrative: Municipal bond mutual funds noticed outflows of over $140 billion, whereas municipal bond ETFs noticed inflows of virtually $30 billion.1
The ETF business has speculated that the municipal bond market is lastly beginning to admire all of the buying and selling, liquidity, and operational efficiencies provided by the ETF automobile, particularly given the broader fixed-income market construction developments lately. I feel that may be a large tailwind for municipal bond ETFs, particularly these with lively administration.
Energetic municipal bond ETFs presently characterize roughly 10% of the general municipal bond ETF market, which stands at somewhat over $100 billion.2 Final 12 months, these lively funds represented roughly 8% of municipal bond ETF inflows.3 I see the general municipal bond ETF pie persevering with to develop and lively administration rising its share of that pie. I predict that greater than 20% of municipal bond ETF inflows in 2023 can be directed towards lively funds.
- Fairness dividend ETFs discover a broader viewers
The fairness ETF market in america is gigantic with roughly $5 trillion of whole property throughout over 2,000 funds.4 The three largest of those fairness ETFs every monitor the S&P 500 Index, cost a mean administration payment of ~5 foundation factors, and account for a staggering ~20% of all fairness ETF property in america.5 For a lot of buyers, these three ETFs alone characterize a core holding of their total portfolio.
Dividend ETFs characterize a much smaller slice of the fairness ETF pie with roughly $370 billion of property and simply 7% of the whole fairness ETF market share.6 These ETFs have been fairly widespread with yield-starved buyers, each as a substitute for bond funds and as a portfolio stabilizer throughout occasions of heightened market volatility.
I’d by no means affiliate dividend investing with a core holding. Nonetheless, the evolution of index investing is unending, so it is not stunning that these two worlds are beginning to converge. Nearly all of preliminary dividend indexes had been designed to maximise revenue, and that may result in unintended dangers, akin to single-security or sector bias. The latter might imply that buyers miss out on broad market financial progress drivers throughout a specific market cycle. Put one other approach, buyers can now ponder how a lot deviation from the market portfolio they’re prepared to take for added yield.
There at the moment are a rising variety of dividend ETFs which might be targeted on yield and supply responsiveness to evolving sector dynamics of the broader market. Let’s name these “core dividend” ETFs. As extra retail buyers strategy retirement, dividend ETFs- as beforehand constructed – will proceed to be widespread. Moreover, as extra buyers admire newer dividend methods that might function a core holding, the property below administration progress potential considerably will increase. I predict that 15% of fairness ETF inflows come from dividend ETF methods.
- ETFs that maintain worldwide equities shine
Final 12 months, my prediction on worldwide fairness ETF investing was targeted on potential supply-chain woes inflicting important efficiency dispersion amongst world fairness markets. In my report card, I famous that the power of the US greenback in relation to native currencies weighed on the efficiency of world fairness ETFs.
I estimate that roughly 20% of fairness ETF property in america solely maintain worldwide equities. The flows into these funds have been surprisingly in line with the one-year, three-year, and five-year percentages throughout 24%.7
I feel there are some actual causes for world optimism. Though not solely behind us, pandemic issues now appear to be much less impactful globally in comparison with the previous couple of years. Native currencies appear to have stabilized (and even strengthened) in relation to the US greenback. Developed European markets did properly in the course of the fourth quarter of 2022, because the euro and the British pound each superior 9.2% and eight.2%, respectively. Japan’s yen additionally appreciated 10.4% towards the US greenback in the course of the remaining quarter, serving to the FTSE Japan RIC Capped Index rise almost 13%.8
Latin American markets had been a shiny spot throughout 2022, given sturdy foreign money efficiency relative to the US greenback. Brazil was a transparent winner amongst main fairness markets with the FTSE Brazil RIC Capped Index ending the 12 months up 12.2%.9 Mexico’s fairness market, as measured by the FTSE Mexico RIC Capped Index, additionally ended within the inexperienced with a fourth-quarter rally of 13.9%.10 Traders have additionally been returning their focus to Chinese language equities in current weeks amid rising convictions that authorities rest of Covid-19 restrictions might quickly gasoline a resumption of client spending. The FTSE China RIC Capped Index was up about 13% for the fourth quarter of 2022.11
Provide chain woes look like abating, probably easing world inflationary pressures. US fairness markets are nonetheless buying and selling at a lot increased valuations than virtually all different world markets, and this might spur discount looking.
Put that every one collectively, and I feel this 12 months we should always lastly see momentum for ETFs that maintain worldwide equities. I predict they are going to account for greater than 40% of fairness ETF flows in america.
Will these predictions play out? Keep tuned!
What Are The Dangers?
All investments contain dangers, together with potential lack of principal. The worth of investments can go down in addition to up, and buyers might not get again the total quantity invested. Usually, these providing potential for increased returns is accompanied by a better diploma of danger. Inventory costs fluctuate, typically quickly and dramatically, on account of components affecting particular person firms, specific industries or sectors, or basic market situations. For actively managed ETFs, there isn’t any assure that the supervisor’s funding choices will produce the specified outcomes.
ETFs commerce like shares, fluctuate in market worth, and should commerce above or under the ETF’s web asset worth. Brokerage commissions and ETF bills will scale back returns. ETF shares could also be purchased or offered all through the day at their market worth on the change on which they’re listed. Nonetheless, there may be no assure that an lively buying and selling marketplace for ETF shares can be developed or maintained or that their itemizing will proceed or stay unchanged. Whereas the shares of ETFs are tradable on secondary markets, they could not readily commerce in all market situations and should commerce at important reductions in intervals of market stress.
1. Supply: Morningstar as of 12/31/22.
7. Supply: Ibid.
8. Sources: Bloomberg and Morningstar Direct as of 12/31/22. Indexes are unmanaged and one can not immediately spend money on them. They don’t embody charges, bills, or gross sales fees. Previous efficiency is just not an indicator of future outcomes. See www.franklintempletondatasources.com for added information supplier info. The FTSE Japan RIC Capped Index represents the efficiency of Japanese large- and mid-capitalization shares.
9. Ibid. The FTSE Brazil RIC Capped Index represents the efficiency of Brazilian large- and mid-capitalization shares.
10. Ibid. The FTSE Mexico RIC Capped Index represents the efficiency of Brazilian large- and mid-capitalization shares.
11. Ibid. The FTSE China RIC Capped Index represents the efficiency of Chinese language large- and mid-capitalization shares.
Editor’s Word: The abstract bullets for this text had been chosen by Searching for Alpha editors.