Franklin Templeton Thoughts: Global ETF 2022 Outlook

What’s ahead for exchange-traded funds (ETFs) globally in 2022? Jason Xavier, our Head of EMEA ETFs Capital Markets, opines on trends he sees taking shape—including the areas of growth.

Capital Markets 2022 Predictions

While our “new normal” may involve periodic vaccinations and possibly antiviral tablets as a permanent fixture, hope for better days appears on the horizon. However, against this gloomy backdrop, the irony is that investors had bullish expectations and the ETF industry boomed over the same period. It has seen increased adoption, growth in assets under management (AUM), new fund issuances and overall validation of its ability to allow investors to reach their investment goals and objectives in a cost-efficient manner.

So, once again the time has come to set some goals, objectives and of course, make some predictions for ETFs in 2022—from a European perspective.

Global ETFs saw a record year in 2021, with close to US$10 trillion in AUM and over US$1 trillion in net new inflows.1 This followed a record year prior, when the COVID-19 volatility test arguably cemented the ETF as a suitable vehicle for efficient risk transfer in volatile markets.

So, what will the landscape potentially look like in 2022? I’ll take a stab at some trends I see ahead.

Prediction 1: Short-dated fixed income ETFs will see the largest relative AUM increase in 2022.

March 2020 and the heightened volatility due to the onset of COVID-19 has widely been acknowledged as the last test of robustness needed for mass adoption of the ETF vehicle. This period of volatility shined a brighter light on fixed income and the ways in which the ETF wrapper can successfully be used by investors seeking liquidity in times of stress. This attribute has been vital for many investors navigating the recent bouts of pandemic volatility. And, in our view, the record ETF net inflow numbers seen over the past two years reinforces the case for the ETF wrapper to serve as a core, tactical and liquidity vehicle that helps many investors meet their fixed income investment goals and objectives.

As the economic backdrop changes and economies reopen, it’s clear many investors are positioning for central banks to respond to inflationary spikes. I’m no economist, so I’ll firmly leave the interest rate and fixed income market commentary to our in-house experts. However, I have seen how duration can impact a portfolio, depending on positioning. Hence, as the market anticipates rising interest rates in 2022, many investors are likely to continue to position to the short end of the yield curve, and I believe short-duration ETFs will likely outperform broad, long-dated fixed income offerings this year.

Prediction 2: Environmental, social and governance (ESG) ETFs will once again double AUM inflows in 2022.

Once again, I feature ESG in this year’s predictions. (If it ain’t broke, don’t fix it!)

Last year, nearly every ETF launch had an ESG tilt, and the momentum behind ESG investing in Europe continues to dominate many conversations. It was once again a record year for European ESG ETF flows, with net inflows doubling in size, seeing US$87 billion pour into European ESG ETFs vs US$43 billion in 2021. The introduction of the European Union’s (EU’s) new Sustainable Finance Disclosure Regulation (SFDR) provided good tailwinds for this, and I see no reason for this trend to stop.

However, I believe investor interest in ETFs that align with the Article 9 classification under the SFDR directive should accelerate. Additionally, interest in ESG ETFs that offer a measurable impact should capture a greater percentage of the inflows this year.

On the fixed income side, the EU expects to issue in excess of €200 billion in green bonds over the next four years—a good opportunity for investors looking to create an impact with their investment. While on the equity side, we believe products that offer a quality tilt will capture the lion’s share of flows this year.

Prediction 3: Global emerging market countries that address pent-up supply-chain issues will bounce in 2022, with AUMs increasing accordingly.

Global supply-chain issues remain front and centre for many businesses reliant on overseas imports and the spiralling costs associated with freight around the world. From semiconductors to plant machinery, the issue is certainly impacting consumers as well as businesses globally. So rare is this scenario that even the secondhand car market in the United Kingdom is for the first time in my lifetime trending upwards as the shortage of new vehicles spills over to the secondhand market.

The world’s manufacturing hubs are still very much skewed to the emerging world. Aside from Germany, the world’s supply chain remains heavily reliant upon China, South Korea, and Taiwan.

While some believe this will be a multi-year issue, others see this normalising later in the year. With that in mind, I believe exporting single-country emerging markets will outperform those that are less focused on key exports, and associated ETF AUMs will rise this year.

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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.

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