Deceleration in global economic growth and continued political and economic instability in Europe mean that investors will likely be seeking to de-risk in an effort to reduce the volatility drag on portfolios, resulting in an increased appetite for defensive equity strategies and high-quality credit ETFs.
That’s one of the key conclusions of BMO Global Asset Management’s 2019 ETF Investment Insights report , which also highlights how investors might turn to fixed income and income-focus equity ETF strategies against the backdrop of economic uncertainty in 2019.
Morgane Delledonne, ETF Investment Strategist at BMO Global Asset Management, says: “The global economy is entering a late-cycle phase, where economic growth remains strong but is losing momentum. Fundamentals look good, but some vulnerabilities are building, including the high level of public and corporate debt and the rise of populism and protectionism. As a result, we expect market volatility will remain elevated through 2019 and market corrections will become more frequent. One way to reduce the volatility drag on long-term returns is through ETF strategies generating high income.”
In fixed income, the report proposes utilising a short-date bond ETF and a longer-dated equivalent, known as a ‘barbell’ strategy, so that investors can potentially minimise interest rate risk while providing higher income.
Alternatively, 1-3-year global investment grade corporate bonds offer diversification benefits and a balance between higher yields and downside protection, the firm writes.
In equities, investing in high dividend companies can involve the risk of falling into a ‘yield trap’, BMO warns. Investors should screen for quality before dividend yield. This is the approach of the BMO Income Leaders ETF range, the report says.
Derivatives strategies, such as the covered call overlay implemented in the BMO Enhanced Income ETF range, can provide superior income and investment growth, the firm says.
The report also reviews 2018’s key macroeconomic and ETF themes, and points out less synchronised growth across the world with global growth decelerating in the first half of the year and moderated activity in Europe while emerging markets expanded.
Trade tensions dampened global trade, BMO says, while US tariffs and the renegotiation of NAFTA led to reduced global trade volumes, and subsequently lower investment.
The strengthened US dollar was also a factor, as the US grew at a faster pace than the remaining advanced economies, the US dollar appreciated versus most currencies from the spring onwards, BMO says.
On the equity ETF front, investors favoured large caps over small caps in 2018, though less so than in 2017. There were net inflows into defensive sectors focused ETFs, while financials focused ETFs saw significant outflows.
On the fixed income ETF side, investors also turned defensive, with a preference for ultra-short and short-dated bonds. There was a huge drop in demand for corporate bonds, while government bond ETFs saw net inflows.
Delledonne says: “With the yield curve now almost flat, the Federal Reserve may increase interest rates one more time in this cycle to reach its long-term median estimate for the fed funds rate. However, it is unlikely to move into restrictive monetary territory if inflation remains close to target. Therefore, we believe the US dollar will plateau this year, benefiting emerging markets and helping to stabilise the US trade balance, which could ease tensions between the US and China. A comprehensive trade deal could have substantial upside potential for emerging markets.”