First, I hope everyone had a wonderful New Year—or at least an opportunity to reset and recharge. After two years of living with COVID-19 and the impacts it has had on the global economy, I remain optimistic that things are slowly getting back to normal and that 2022 will see even more of a return to normalcy.
This is my sixth year of giving ETF-related predictions. As I reread some of the prior posts, I noticed the same themes recurring in my predictions—fixed income ETF increases, active ETF adoption, smaller funds getting bigger, etc. For this year, I tried to avoid those themes while also avoiding specific market calls on interest rates or S&P 500 Index end-of-year levels (not my forte).
You might rightfully be wondering what is left after omitting all those topics, but rest assured as there’s still plenty! On to my top three 2022 predictions.
- Mutual fund-to-ETF conversions will continue to gain traction.
Since the beginning of this blog, I have repeatedly outlined many of the trading and structural nuances of ETFs that make them so attractive, such as their liquidity, daily transparency, ecosystem, tax efficiency, etc. Judging by the 2021 inflows in the United States, which were within spitting distance of $1 trillion dollars, I am not the only one who thinks this way about ETFs.
Last year was the first year in which we saw a decent number of mutual funds convert into ETFs, most likely for some combination of those reasons I listed above. The 2021 numbers were impressive; I counted 16 mutual funds converted to ETFs last year, with those ETFs having a combined $37 billion in assets.1
I think both of those numbers will double in 2022, and I would not be surprised if ETFs that had former lives as mutual funds exceed $100 billion this year.
- Global supply-chain concerns will once again shine a spotlight on international equity investing.
To be honest, I am not sure what to make of the recent headlines on the global supply chain as they are all over the place! Within the last couple of weeks, for every article that estimated global supply-chain issues could last a year or two longer, there was another that said everything should be resolved by this summer.
Many of the countries that serve as manufacturing centers within the global supply chain—for example, Germany, China, Hong Kong, South Korea and Taiwan—had very different equity returns last year. Chinese equity markets were down almost 25% while Taiwanese equity markets were up over 25%.2 German equities were up a little on the year while those from Hong Kong and South Korea were slightly down.
I may not have a strong opinion on whether or when these supply-chain issues will be resolved, but many investors most certainly do. That makes the ability to have targeted exposure using single-country ETFs that much more important. And as for a prediction, I think that we should once again see significant performance dispersion among ETFs that provide exposure to a single country’s equity markets.
- Environmental, Social and Governance (ESG)/Sustainable ETFs will exceed $200 billion of assets under management (AUM).
I’m a bit surprised I haven’t previously made an ESG-related prediction. I am bullish on ESG investing and think it will continue to gain popularity. However, before getting to a prediction, I wanted to talk a little about the “bigger picture” decision-making that goes into choosing an ETF.
The first articles within this blog debunked misconceptions around using counting stats such as average volume or AUM when selecting an ETF. Hopefully we’ve succeeded in getting investors comfortable trading all ETFs, even the newer ones.
Assuming that investors are now comfortable trading any ETF, what should go into the ETF selection decision, especially given all the index and active ETFs available? I like to look at the two extremes of the index/active ETF spectrum (barbell/hourglass). If your goal is simply to have exposure to a given market, then going with the lowest-cost index ETF makes a ton of sense. On the other end of the spectrum, if you are looking for a specific portfolio philosophy, then active management is a great option (and management fee screening becomes less important.)
I think ESG is a philosophy that can add value on both ends of the ETF selection spectrum. There are low-cost ESG index funds that provide broad market exposure with an ESG tilt. Furthermore, you can also find bottom-up active stock-picking with the addition of ESG screens. As options on both ends of the spectrum continue to grow and investors appreciate that they can maintain diversified exposure with an ESG screen, the environment appears ripe for significant asset growth.
I estimate that 2021 closed with ~$126 billion of assets in sustainable ETFs (which includes ESG and non-ESG funds) with $38 billion of inflows in 2021.3 I think we easily beat that number in 2022 and close the year well over $200 billion.
Will these predictions play out? Stay tuned!
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 favor 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 realized. 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.
Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.
___________________________
1. Sources: New York Stock Exchange, Chicago Board Options Exchange, NASDAQ, as of 12/31/21.
2. Source: Bloomberg, as of 12/31/21. Past performance is not an indicator or a guarantee of future results.
3. Source: Morningstar, as of 12/31/21.
