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David Stephenson, director ETF strategy and development, CIBC Asset Management.
Looking back in 2019 I think there were two significant surprises. The first, and maybe the story of the year, was declining bond yields in both Canada and the U.S., which certainly was not the market consensus heading into the year. Yields were down across the yield curve in both Canada and the U.S. For example, the 10-year yield in Canada declined 26 basis points while in the U.S. the 10-year was down 77 basis points. As a result, bonds had a very good year. The Canadian bond market was up 6.9%, the best year since 2014. Longer duration bonds did even better, returning 12.7%.
The second observation was just the strength of equity markets and how broad based performance was — not only across global markets, but within sectors and even asset classes. In the S&P 500, for example, 90% of the stocks were up in 2019 with almost 80% up 10% or more. In short, everything seemed to be up, whether it was gold, commodities, the Canadian dollar or international markets.
As an example to illustrate this, the S&P/TSX Composite Index returned 22.9% last year, posting its best year since 2009. When you take a step back and look at the markets last year, lower interest rates won out in 2019, leading to multiple expansion and higher stock markets counterbalancing the negative overhang of inverted yield curves, U.S.-China trade tensions, economic uncertainty and negative interest rates globally over the course of 2019.
How did this impact the ETF industry and flows in 2019? First of all, the ETF industry had a record year, bringing in almost $28 billion, surpassing the previous high of $25.8 billion in 2017. As well, towards the end of the year, total industry assets hit the $200 billion milestone, ending the year at $205 billion. I think this sets the ETF industry up nicely for continued strong growth over the next few years.
What’s interesting in looking at these flows is how defensive investors were in 2019. Fixed income and so-called safety trades dominated flows. In fact, fixed income accounted for over 50% of ETF flows in 2019. Looking under the hood a little more, low cost, broad market, Canadian aggregate bonds and high interest savings account ETFs saw huge investor interest. Fixed income assets are now approximately $66 billion or one-third of total industry assets and have more than doubled over the last three years. On the equity side, flows into low-cost U.S. and international ETFs did well on a relative basis, but interest in factor ETFs continues to grow, such as low-volatility and multifactor ETFs that combine different factors into one product such as value, momentum and quality.
What trends do I think will take off in 2020? I think fixed income will continue to grow as investors increasingly adopt ETFs and where we will continue to see product innovation, particularly active fixed income. Although Canadian aggregate bonds are a core holding in most investor portfolios and offer stability and diversification, yields are currently in the 2% range with a duration of approximately eight years. Looking out over the next three to five years and beyond, this could potentially pose an issue for investors looking for yield. In fact, we are starting to see ETFs launch that try to seek a better balance between interest rate risk — so duration and credit risk — to generate better yields, and active managers are positioned accordingly. Therefore, I believe — to mention a specific area — is that go-anywhere, flexible international fixed income ETFs will see continued interest and can help diversify investor portfolios.
Having access to a broad opportunity set across fixed income can also mitigate risk but also provide flexibility to tactically adjust sector weights to take advantage of opportunities, as well as managing duration exposure to capture opportunities in any interest rate environment. International fixed income grew considerably in 2019, and I expect that to continue into 2020 and beyond. I also think we will see a continued playing-defense stance from investors, so products that help people stay invested while lowering risk will also be popular. Examples are low volatility, dividend and outcome-oriented products like alternatives. Solution products like one-ticket asset allocation ETFs will continue to attract assets as well. Another area to watch in 2020 will be thematic ETFs. In particular, ESG. There were quite a few launched in 2019 and more to come in 2020 so this will be interesting to watch flows. Overall, 2019 was a great year, and I think the best years for the ETF industry are still ahead.