High inflation and aggressive monetary tightening have roiled financial markets this year. “To say the least, there is a lot going on,” says Gargi Chaudhuri, Head of iShares Investment Strategy Americas at BlackRock. “Economies everywhere are facing the challenge of higher inflation and higher interest rates in a slowing growth environment.”
One way investors are responding to this is by increasing use of exchange-traded funds (ETFs) in their portfolios, to help manage volatility and capture opportunities in this period of market turmoil. “We’ve definitely seen increased adoption of ETFs across all client segments,” says Helen Hayes, Head of iShares Canada, “not only from a retail perspective, but also among pensions, asset managers and family offices,” she adds. “In fact, as of the end of September, the Canadian ETF industry overall marked organic growth of 7.2% this year.”
Helen Hayes Head of iShares Canada, BlackRock
In a study of institutional investors worldwide at the beginning of the year, it was found that 43% of North American institutional investors are more likely to increase their use of ETFs over the next 18 months. “We’ve seen institutional investors continue to use ETFs for a range of both tactical and strategic purposes, from low-cost building blocks in portfolio construction to alternative uses,” shares Hayes “For instance, we’re seeing clients use ETFs as a complement to derivative strategies or implementing factor investing using ETFs.” Hayes also explains that in difficult market conditions, ETF liquidity is a key benefit. This is especially the case in fixed income, “every time we’ve seen increased volatility across global markets, we’ve also seen increased strategic liquidity management from a fixed income perspective,” says Hayes. On a more positive note, Hayes explains, institutional investors are also taking advantage of the diverse lineup of ETFs in both stocks and bonds for tactical allocations to specific market segments or geographies.
In Chaudhuri’s view, macro factors – higher inflation, rising discount rates and geopolitical uncertainty – are increasing the likelihood of an economic downturn in Canada and elsewhere. That would clearly impact corporate earnings to an extent that may not yet be fully priced into equity valuations, Chaudhuri adds, and she expects continued volatility in stocks at least until central banks pause their tightening cycle. As a result, “we remain generally defensive on the equity side,” she says.
Given the challenges, Chaudhuri recommends investors consider equity exposures that can help mitigate volatility and focus on quality. Two options to consider: iShares MSCI Min Vol USA Index ETF (XMU), which offers lower-beta exposures to high-quality equities, and iShares Core MSCI Quality Dividend Index ETF (XDU), which tracks a portfolio of U.S. stocks with strong financials, above-average dividend yields and steady or increasing dividends.
Gargi Chaudhuri Head of iShares Investment Strategy Americas, BlackRock
Chaudhuri adds, however, that investors might find alpha-generating opportunities in commodities equities, particularly in energy and agriculture. The disruptions to global food and energy supply chains partly due to geopolitical tensions, and future production increases are limited by a history of under-investment – two factors that may support prices and corporate earnings going forward. With iShares Core S&P/TSX Capped Composite Index ETF (XIC), investors can gain broad exposure to the commodity-heavy Canadian market, while iShares S&P/TSX Capped Energy Index ETF (XEG) and iShares Global Agricultural Index ETF (COW) offer more targeted exposures.
While she suggests playing defense on equities, Chaudhuri says that bonds are a different story. In fact, yields have risen so much that fixed income now offers some attractive income generation. As well, bonds could provide ballast to equity allocations in case of a downturn, as they traditionally have. Meanwhile, Chaudhuri says macro forces suggest that higher inflation might persist over the short to medium term, making inflation-linked bonds attractive. “We think bonds now bring pockets of opportunity,” she explains, “and specifically short-term corporate bonds and the front end of the inflation-linked market.”
To express those views, investors could consider iShares Core Canadian Short-Term Bond and Short-Term Corporate Bond Index ETFs (XSB and XSH), iShares 1-5 Year U.S. IG Corporate Bond Index ETF (CAD-Hedged) (XIGS), and iShares 0-5 Year TIPS Bond Index ETF (CAD-Hedged) (XSTH), which tracks inflation-indexed U.S. Treasuries with maturities of less than five years.
There is no doubt 2022 has been a challenging year for financial markets. Yet ETFs are helping institutional investors tap into the benefits of their low cost, liquidity, price discovery and the ability to take advantage of opportunities – in any market condition.
 As of September 30, 2022. Source: BlackRock  Institutional Investor study, Q1 2022: https://www.ishares.com/us/resources/institutional-investors/responding-to-uncertainty
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