• Australian ETF market in 2022 has dropped by just under $2bn to end of November 
  • Inflation and rising interest rates have driven investor behaviour in 2022 with growth, tech-ETFs hit 
  • This year investors faced the rare broad sell off in both equities and bonds at the same time

It’s been a volatile year on global equity markets. Global X Australia Head of Investment Strategy Blair Hannon said the net size of the Australian ETF market in 2022 has dropped by just under $2 billion to the end of November because the markets have fallen.

“ETFs are what we call beta-linked so if markets go down by a certain amount then the size of the ETF market will go down a similar amount,” he said.

“But positively we continue to see very positive net inflows into ETFs ($12.5 billion year to date) so while the total market size may be down slightly investors are still allocating into ETFs and it shows they have a place in all market cycles.”

Hannon said Global X Australia sees the total Australian ETF market size reaching $500 billion in the next five to six years with the tailwinds of ETF adoption and markets hopefully improving over that time frame.

So, what has been the three biggest impacts on the Australian ETF market in 2022?

1.Inflation and rising interest rates

Hannon said inflation both in Australia and overseas has driven investor behaviour throughout 2022.  Interest rates have been rising globally as inflation rates not seen since the 1990s took hold.

The RBA raised the cash rate by 25bps to 3.1% in its December meeting,  the eighth straight rate rise since it started lifting the cash rate from a record low of 0.1% in early May .

The cash rate is now at its highest level in a decade as the RBA has worked to put the inflation genie back in the bottle.

“You have inflation ramping up putting pressure on growth stocks and which has seen, for example, tech focused ETFs and thematics really sold off, some by 0ver 30%,” Hannon said.

“If you’re a tech company which have revenues but not necessarily strong profits or earnings and may also have debt that’s when inflation is going to have a large impact by hitting growth stocks more than traditional value stocks.”

2. Broad sell off in equities and bonds in 2022

Hannon said while inflation and associated interest rate rises has seen a broad sell-off in equity markets in 2022, there has also been an unprecedented sell-off in bond markets at the same time, which has pushed yields higher.

It is an unusual phenomena to see both bonds and equities fall simultaneously with basic economic theory teaching there’s an inverse relationship in bonds and share markets.

When there’s prolonged price declines in equities, bond prices generally rise as investors seek a safe haven.

“When investors go to a financial advisor for example they will be given an asset allocation and that is usually built around shares or equities and fixed income like bonds,” he said.

“It’s the 60-40 portfolio where you have 60% equities or 4o% in fixed income.

“Normally you would see fixed income as the ballast of your portfolio, which looks to protect you in times of volatility in markets.”

But markets haven’t been behaving like the textbooks this year with both bonds and equities coming under pressure.

“Earlier this year we saw a sell off in equities at the same time as a continued sell off in bonds so it’s difficult for an investor to know what to do so what a lot did do was sit on the sidelines and wait,” Hannon said.

He said the correlation between fixed income and equities has started to normalise towards the year end seeing money flow back into fixed income and specifically fixed income ETFs.

“We’ve seen quite a lot of flow into some fixed income funds as investors for the first time in probably 10 years start to get yield, especially in the safe havens of US Treasuries or Australian Government bonds,” he said.

“It’s definitely an interesting time with how you can build a portfolio looking to get income as well.”

3. Rising US dollar impacts in 2022

Hannon said the Aussie dollar which has been sold off significantly in 2022 has had a net positive effect for international investments.

“If you were to invest into US equities because the US dollar went up and Aussie dollar came down then you have a net benefit from that,” he said.

However, he said in 2023 if the Aussie dollar starts to retrace higher (US dollar comes off), then investors need to start to think should they be hedged to not be impacted by that headwind?

“When the Aussie dollar is falling its a tailwind but if it’s rising it’s a headwind and we are starting to see people considering hedging across the international exposures in their portfolio now,” Hannon said.

Looking ahead to 2023

Hannon said while he doesn’t have a crystal ball and its hard to know exactly what will happen in 2023 it does feel like perhaps rates are closer to being paused or towards the end of a rising cycle.

“Interest rates have such a broad effect across all asset classes from equities to fixed income so I think that markets have somewhat priced in rate expectations now, particularly around the very closely watched US Federal Reserve which we know is so vital to global equity markets,” he said.

“Then we have the US dollar and for emerging markets they have had a tough time with the rising US dollar in 2022.

“Any change in expectation where the US dollar won’t be as strong will be a tail wind for emerging market equities so you may see some more inflows to this currently unloved exposure.”

Hannon said furthermore if China continues to soften its strong Covid-19 zero policy this may be a further boost to emerging markets in 2022.

“ETF users are somewhat momentum traders in that they will follow where the markets are moving so if emerging markets start to pick up then we might see more allocation to the sector whereas China for example has been seen as not investible at all for much of this year for many investors,” he said.

Hannon said the decarbonisation trend was also likely to continue growing in 2023.

“We’ve been getting a lot of good investor feedback on the whole theme of decarbonisation and this is where ETFs, in particular thematic ETFs, really come into their own,” he said.

“ETFs are an easy way to invest in the decarbonisation theme as it gives investors directors access to the theme especially via investing into offshore markets and they don’t have to be as focused on the researching and individual stock picking.

“We are seeing more consistent data points coming out on decarbonisation, the most recent being COP27 summit where they said a US$4 to $6 trillion spend into the renewable space is needed by 2030 if we are going to get anywhere close to net zero by 2050.”

He said that big spend has to go somewhere including into solar and wind power along with material needed such as copper and green metals.