Reasons to Start 2023 with Encouragement - Year End ETF Review and Outlook

I think we can all agree, 2022 was another year we wish we can all forget. After two tough years since the start of the COVID-19 pandemic, many hoped 2022 would offer a light at the end of the tunnel. But those hopes were hijacked by market volatility, war, inflation, and interest rate increases. It will be quite interesting to see what lies ahead for us in 2023.

In the ETF world, positive flows were sustained throughout 2022 and a wide range of new products were launched, even with all the volatility in the marketplace. A 2022 year in ETF review offers some encouragement to ETF investors.

ETF Flows Review

According to National Bank’s Canadian ETF Flows Report, Canada finished the year with $35.5 billion in net inflows, down $17.5 billion from the record breaking $53 billion in 2021.1 U.S. markets continued to grow at a record pace, with the second largest AUM flows in history of US$610 billion in net inflows, down $333 billion from last year’s inflows of US$943 billion.2

Equity ETFs outsold fixed income ETFs for 2022 in Canada, though Cash ETF raised $15 billion as bond ETF sold off. US had similar results with equity ETFs leading the way over fixed income ETFs.

ETF growth in Canada over the past five years has seen ETF net inflows outpacing those of mutual funds generally; only in 2021 did mutual funds outsell ETFs. U.S. sales remained consistent in 2022 as ETFs continued to outpace mutual funds, as has been the case there every year since 2008.

There were 152 ETFs launched in Canada last year, with 32 ETFs correspondingly delisted, bringing the total ETF count to 1,299. Actively managed ETFs made up 109 or 72% of those new launches.1

In the U.S., mutual fund to ETF conversions were a big deal for traditional mutual fund companies. A total $25.7 billion in active mutual fund mandates was converted into ETF AUM.2

Canada remained at the forefront of innovation in 2022, with the launch of slightly levered ETFs, providing 25% to 33% in leverage for higher income needs. A total of 25 products are now available to investors, and amassed $1.5 billion in assets in 2022.

ESG is now the largest category in thematic ETFs in Canada, with infrastructure and agriculture rounding out the top three categories.

In terms of passive ETFs, indexed-based ETFs continued to attract 60% of industry flows, with ETFs priced 30 basis points (bps) and lower. Franklin Templeton ETFs again entered the low cost passive space with the launch of FLEM (Franklin Emerging Markets Equity Index ETF) and FLUR (Franklin International Equity Index ETF) on December 21st. FLEM is an emerging market mandate that provides the lowest fee exposure in the Morningstar emerging market ETF category at 0.15%. FLUR has a broader geographic mandate to invest in developed markets ex North America at a low cost of 0.09%, making it also the lowest fee in the Morningstar international ETF category as well.3

On average, the management fees of FLUR and FLEM are 77% and 71% lower than that of the International Equity Category and Emerging Markets Equity Category for ETFs, respectively.3

ETF Outlook

Looking ahead to 2023, inflation could finally peak and rate hikes may slow down. I believe advisors will look to continue investing in higher quality and yield-driven exposures for equities while remaining cautious. ETFs in the areas of infrastructure, strategic beta aimed at quality, and value factors will be in focus.

For fixed income, it will be a great comeback year if interest rates level off and or have to be cut for deflationary measures. I would continue to look at ultra-short duration strategies to enhance cash positions, and unconstrained or mid to longer duration strategies to take advantage of higher income opportunities with recession worries on the horizon.

Forecasting is something of a fool’s errand, but one feature of the markets remains no matter the outlook: there will be opportunities to produce returns and income for your ETF portfolio in 2023 but also risks to navigate. That’s why I’m glad to see the continued growth of the ETF industry with enhanced options now available to investors seeking greater choice and diversification for their portfolios. 

Source:

1. National Bank’s Canadian Flows Report

2. National Bank's US Flows Report

3. Morningstar Direct

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, 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. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.