Global ETF 2023 outlook: Playing defence and investing tactically

by | Jan 3, 2023

Written by Jason Xavier, Head of EMEA ETF Capital Markets, Franklin Templeton

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, our industry predictions are as follows.

  1. Multi-factor smart beta ETFs will attract more investor flows

Our 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.

  1. 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. 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.

We 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.

  1. 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.

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