Equity ETFs: themes and outlook for 2022

With more than $155 billion of net new assets gathered during the first 10 months of 2021, the exchange-traded fund (ETF) market in Europe is on track for its most successful year in history. Three-quarters of these flows have been into equity ETFs and we think investors will continue turning to ETFs to track core benchmarks and gain efficient and often innovative exposure to many of the themes that could take centre stage in the new year.
More responsible investing
ETFs that apply environmental, social and governance (ESG) criteria have taken more than half of all equity ETF inflows in the first 10 months of the year, and 2022 could be even more significant. We expect to see a continuation of broad ESG ETFs used to replace core equity holdings as investors seek to reduce ESG risks in their portfolios and think many will be fine-tuning those portfolios especially in terms of the environment. Worldwide endeavours to reduce the amount of global warming to 1.5°C, in line with the Paris Agreement on climate change, is likely to impact most industries – either for better or for worse – and ETF investors can choose from a diverse range of solutions that consider these factors.
Major index houses including MSCI and FTSE are creating benchmarks that not only seek to improve overall ESG scores but also meet specific climate-related objectives, such as aligning with the Paris Agreement. An index might, for instance, aim to reduce climate risks by a certain percentage and increase exposure to companies with revenues from “green” technologies. Of course, the more changes made to an index, the more the performance is likely to vary in respect of the parent index, so some investors may wish to consider an acceptable level of tracking error to reach their ESG, climate and other non-financial objectives. Fortunately, investors should be able to find suitable solutions through ETFs with full transparency of the underlying index methodology and objectives.
Clean energy
Aside from using ETFs for core holdings – of both the ESG and non-ESG varieties – we also expect to see further demand for thematic exposures for strategic and tactical positioning. These include ones linked to the environment, such as those investing in companies involved in clean energy technologies. Reducing the world’s dependency on fossil fuels and in particular coal will be crucial in cutting harmful emissions and achieving “net zero” targets by 2050 (or 2060 for China and 2070 for India). Using renewables such as solar and wind for electricity generation is increasingly justifiable from an economic perspective, with the cost of solar having fallen by 85% over the past decade. In many parts of the world, new solar power plants are cheaper than those using the cheapest fossil fuel.
We believe the clean energy space goes well beyond manufacturers of solar panels and wind turbines and achieving climate objectives will require investment and additional solutions. Finding more efficient ways to store the energy captured from the sun, wind, waves, etc., should be key to meet 24/7 needs. We also need to use energy more efficiently, including in buildings, as well as developing other clean energy solutions for industries in which solar and wind generation are inefficient, such as shipping, where hydrogen is emerging as the most feasible option. There are several methods for producing hydrogen, and while there may be a push for blue hydrogen (produced from natural gas) as a more immediate solution, green hydrogen (produced by hydrolysis using renewable electricity) is the preferred longer-term solution.
These are just a few of the many areas where we believe investment and demand could continue to grow. ETF investors can gain exposure either to the broad clean energy theme or to specific segments like the solar industry. Such is the size and breadth of opportunity that even an ETF with a narrow focus can still offer diversification across geography, sector and market capitalisation.
Climate change also has an ecological impact. We believe that thematic investments that focus on companies involved in improving water quality and scarcity as well as preserving other natural resources and biodiversity are likely to gather momentum as the investable opportunities evolve.
Continuing the innovation theme
Clean energy and other climate-related themes aren’t the only areas worth considering in 2022. Innovation is also evident across many non-energy-related sectors, driven largely by technological advancements. The blockchain technology is a good example and, while it is often thought of as the distributed ledger that makes cryptocurrencies possible, that is only one application. Blockchain is also being adopted by leading companies in most sectors, including health care, financial services, consumer discretionary and industrials. Blockchain is enabling companies to improve efficiencies, reduce costs and in many cases increase revenue. ETFs that target these companies offer investors an effective way to gain exposure to continued growth in this transformative, disruptive technology.
But what about China?
While China clearly has several issues to address, it plays a significant role in the global economy, both in terms of supply and demand, so every investor needs to decide how, or if, to gain exposure to its equity markets. China has spent decades working on infrastructure to support urbanisation and the rise in the middle class. More recently, attention has turned to the environment, especially with China agreeing to reach net zero by 2060. At present, China is one of the world’s biggest polluters with high coal dependency. The encouraging news is that China appears to have the ambition and resources to change. Beijing’s latest Five-Year Plan includes initiatives designed to make China a global leader in clean energy technology and innovation more generally. Investors can gain access to China either broadly or through ETFs offering more specific thematic exposures.
Conclusion
ETFs are often thought of as low-cost vehicles to track common benchmarks such as the S&P 500 and MSCI World indices, we believe investors will use them increasingly for other exposures. We have seen this trend in recent years and 2022 should be no exception. If anything, thematic as well as more innovative ESG and climate-targeted exposures could capture even more of the overall ETF flow. As the world reopens, we think that investors will look around and see quite a few interesting opportunities, and ETFs that offer effective ways to access them.
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