Using ETFs as inflation persists

As investors continue to face volatile markets and worry about a recession, the best approach may to be focus on what they can control, said David Stephenson, director, ETF strategy and development at CIBC Asset Management.

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“We are in a fundamentally different market environment from the one we’ve seen over the last decade, driven by higher inflation, tighter monetary policy and elevated geopolitical risk,” Stephenson said in an interview.

Against that backdrop, investors should stay disciplined, diversified and focused on long-term goals, he said — basically, they should “focus on what they control.” And ETFs are a valuable tool to get there.

“In this type of macro environment, ETFs have provided a great tool for investors to deliver specific portfolio outcomes,” Stephenson said in an interview.

Which ETF strategies have been effective in this environment?

To hedge against inflation, Stephenson said ETFs focused on energy, commodities and infrastructure have been effective.

Assets in infrastructure are often explicitly linked to inflation and can pass on increases to consumers, he said. Consumer staples, such as grocery chains, have the same benefit of being able to pass on higher prices to consumers.

As the risk of a recession increases, many investors are combining passive exposure with active risk and tilting toward defensive sectors, Stephenson said.

For example, the only two sectors in the S&P/TSX Composite with positive returns year to date are energy and consumer staples, he said.

“ETFs make it very easy to express active use, either using passive exposures or actively managed strategies,” Stephenson said.

Despite market volatility, flows into ETFs totalled almost $24 billion as of Oct. 31. Defensive funds such as cash alternatives and short-term bonds have dominated, but flows returned into equity funds last month.

In this market, Stephenson said he likes low-volatility dividend ETFs. Dividends typically contribute a larger share of total return during volatile periods, he said, and low-vol strategies offer downside protection and a smoother return profile. 

Combined, he said these two strategies can provide higher yields while mitigating risk. 

Lastly, Stephenson said there are opportunities globally for active managers who focus on companies with attractive valuations and higher growth prospects. Historically, he said unusually high volatility leads to a high spread in valuations, which is a good environment to add value via stock picking.

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