De-risking in an effort to reduce the volatility drag on portfolios remains a key ETF investment strategy for 2019, according to Morgane Delledonne, ETF Investment Strategist at BMO Global Asset Management (BMO GAM).
Morgane Delledonne, ETF Investment Strategist at BMO Global Asset Management.
In the firm’s ETF Investment Insights EMEA report for 2019, Delledonne notes that deceleration in global economic growth and continued political and economic instability in Europe will generate increased appetite for defensive ETFs such as those providing exposure to high-income equities and high-quality credit.
Delledonne commented, “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.”
On the fixed income side, Delledonne suggests investors can potentially minimize interest rate risk while providing higher income by utilizing a ‘barbell’ strategy – the combination of a short-dated bond ETF with a longer-dated equivalent.
Alternatively, investors may wish to increase their allocation to ETFs targeting shorter-term (1-3 year) global investment grade corporate bonds, which offer diversification benefits and a balance between higher yields and downside protection.
Turning to equities, Delledonne reminds investors that pursuing an income strategy that purely seeks out the highest yielding firms runs the risk of falling into a ‘yield trap’, where yields are not sustainable and dividends are subsequently reduced or scrapped. Investors may look to the BMO Income Leaders ETF range for a solution that screens for quality firms before dividend yield.
BMO GAM also offers the BMO Enhanced Income ETF range which utilizes derivatives strategies, such as covered call overlays, in a bid to provide superior income and investment growth.
Looking back at 2018, and ahead to 2019
The report also reviewed key macroeconomic and ETF themes observed during 2018.
It noted a slowdown in global growth during the first half of the year; in particular, activity moderated in Europe while emerging markets expanded. Trade tensions took its toll, as US tariffs and the renegotiation of NAFTA led to reduced global trade volumes, and subsequently lower investment.
The US dollar notably strengthened due to the faster pace of growth in the US compared to the remaining advanced economies.
On the equity ETF front, investors continued to favour large caps over small caps, though less so than in 2017. There were net inflows into defensive sector ETFs, while financials sector ETFs saw significant outflows.
Within fixed income, investors also turned defensive, with a preference for ultra-short and short-dated bond ETFs. There was a huge drop in demand for corporate bond ETFs, while government bond ETFs saw net inflows.
Delledonne concluded, “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 stabilize 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.”