Is ETF innovation in Europe lacking as investors prepare for stagflation?

ETF issuers have focused on ESG and crypto

ESG, thematics and cryptocurrencies are just three examples of key focuses for ETF issuers in Europe over the past few years, however, none of these are arguably equipping investors for the current market environment.

Last week, US ETF issuer Merk Investments launched a stagflation ETF, the Merk Stagflation ETF (STGF), which dynamically allocates to inflation-protected bonds, commodities and real estate to protect investors from a such period as the 1970s when inflation rates were sky high and commodities prices were booming.

While this ETF, in particular, would likely not appeal to professional investors who want to control the asset allocation themselves instead of leaving it to the ETF issuer, it does highlight how providers in the US are constantly looking to offer innovative solutions for investors.

There is no doubt innovation is a cornerstone of the European ETF industry, however, the boom in ESG and crypto in recent years has left little room for focus on other areas of the market.

Highlighting this, there are now over 80 crypto ETPs in Europe despite the first one only launching in 2018 while the boom in thematic and ESG ETF launches is well documented. It must be said, this has been a buyside phenomenon with ESG ETFs accounting for 51% of total European ETF inflows in 2021, according to data from Morningstar.

However, the shift to a rising inflationary environment has meant investor demand for growth-orientated strategies is diminishing. According to Morningstar, thematic ETFs in Europe saw just €600m inflows in Q1, the first time the asset class has seen under €1bn inflows since Q4 2019.

Furthermore, inflation-linked ETFs – which saw a record $4.4bn inflows globally in May 2021, according to data from BlackRock – may no longer provide the protection investors need in this rising interest rate environment.

“TIPS carry considerably more duration risk relative to other sectors of the fixed income markets. As a result, any benefits received for changes in the level of inflation might be overwhelmed by the losses due to the longer duration profile,” analysts at US firm Verus explained.

This leaves investors in Europe with fewer options, especially in areas such as real estate, an asset class that tends to perform well in inflationary environments.

While the lack of alternative ETFs in Europe is well documented, there are other parts of the ETF market investors have been accessing in preparation for a 1970s-style environment.

With central banks hiking rates as highlighted by the Federal Reserve and Bank of England last week, investors have been eyeing floating rate bond ETFs. Europe’s largest ETF, the iShares $ Floating Rate Bond UCITS ETF (FLOT), for example, has seen $733m inflows so far this year, as at 6 May, according to data from ETFLogic.

Elsewhere, high dividend ETFs have also been in vogue in 2022 as investors seek exposure to companies that have a track record of increasing dividend payments year-on-year, ideal for a more volatile market environment.

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