Close Close
ThinkAdvisor
Dave Nadig

Portfolio > ETFs > Broad Market

Watch for These ETF Trends in 2023: Dave Nadig

By Dinah Wisenberg Brin

X
Your article was successfully shared with the contacts you provided.

The financial system is working “surprisingly well” despite the volatile market year — a year on track to be the second biggest for flows into U.S. exchange-traded funds after 2021, according to Dave Nadig, financial futurist at data and analytics firm VettaFi.

Nadig, an ETF expert, recently answered ThinkAdvisor’s questions on what’s happening with these increasingly popular vehicles — and what investors might expect for ETFs and the financial markets in general in 2023. 

Nadig encouraged attendance at a February conference about positioning ETFs in client portfolios and how advisors are running their businesses better around ETFs.

Here is an edited version of our interview.

THINKADVISOR: How has this year’s market affected what’s happening in ETFs?

DAVE NADIG: Broadly, what we’ve seen happen in this downturn is what we’ve seen happen in frankly every downturn since 1993, which is when things get squirrely, when we have major asset class drawdowns, people universally sell their underperforming actively managed mutual funds and they buy low-cost index-based ETFs.

Every time that happens it acts like a foot on the accelerator of ETF adoption versus traditional mutual funds. That has been even more the case than usual this year. 

Currently (early December) we’re sitting at about $800 billion out of traditional mutual funds, of which about $500 billion is fixed income. 

So that’s just an enormous tsunami of capital fleeing the traditional mutual fund structure. Meanwhile we’re sitting close to record flows, we’ll probably close this year with something like $600 billion in inflows in ETFs. … You can make that somewhat causal connection that this was an opportunity for investors and advisors to reconfigure their portfolios into more efficient solutions.

Overall every asset class has had net inflows on the ETF side of things. We’ve also seen active management really have a role in there, something around 10%, 15% of the flows have gone into active managed products.

With the markets hit so hard, were people looking to save anywhere they could?

There’s some of that. There is a tax-loss harvesting piece of this as well. If you’ve been a long-term investor in some actively managed mutual fund, it may have been underperforming for the last four or five years but it was still positive. … There hasn’t been an opportunity to sell anything at a loss because pretty much everything’s been sitting there at a gain.

That’s a conversation an advisor can have with their client, to say, “Hey look, we haven’t been happy with the performance of this fund for the past four or five years, we just took a bath on it, now is the time to sell it because, hey, we’ve got some gains over here on the other side of the portfolio, or hey, we’re going to bank those gains and at least write a couple grand off your income.”

Now is a great time to do that. And when people do that they tend to rotate into like but not identical types of exposures (on the ETF side).

So this is an opportunity to get into a lower-cost, more tax-efficient vehicle?

Exactly. The average ETF has an expense ratio … nearly half a percentage point cheaper than the average actively managed mutual fund. And so that matters over the long term, obviously. That message has come across. If you look at where the money is going inside ETFs as well, it’s pretty easy to see what’s been going on.

Vanguard has just been absolutely hoovering up assets. They’re currently the second largest asset manager in the ETF space behind BlackRock, but they’re only about $300 billion behind. Which sounds like a big number, but in the ETF space, honestly, the way flow trends have gone, Vanguard could be bigger than BlackRock in the ETF space by April.

And that is a sign that the message around low-cost indexing … has really gotten out there, not just to advised clients who have been ahead of that curve, but to the broader retail market.

Is actively managed the fastest growing area for ETFs?

It’s certainly one of the fastest areas. It’s where we’ve seen a lot of launches this year. …

I think we’re up over 400 products this year that have come to market. (Bloomberg reported 422 new U.S. ETF launches this year as of Dec. 7.) The good news is if you look at what types of products have come to market, most of them are pretty useful, meaning they’re filling a niche or they’re exploiting a particular distribution area that may have been uncovered.

Things like the single stock ETFs, very narrow point solutions for traders who needed individualized solutions. Some thematic products, dividend products, a lot of fixed income activity, individual bond slices … those are real innovations that are changing how people build portfolios.

How do actively managed ETF expense ratios compare to competing products?

The good news for ETF investors is, pretty universally, an actively managed strategy that has a mutual fund clone or similar type strategy, the pricing on the ETF side is almost always the institutional pricing or better.

So the ETF really is not competing with those old A shares that nobody really buys anymore on the retail mutual fund side of things, it’s really competing with institutional asset management. It’s competing with SMAs (separately managed accounts) that institutions are using. … 

It’s almost universally true that if there is an active strategy available in ETF format, it’s probably about the cheapest way to get that exposure.

How should financial advisors work with clients on using ETFs, and can investors rely solely on ETFs in their portfolios?

Yes, you can really run a world-class institutional portfolio using nothing but a handful of ETFs. That continues to be one of the reasons ETFs are just the anchor product for most financial advisors and increasingly the anchor product for large institutions. It’s not uncommon now to look at the 13F filing of a big pension or a big endowment and see almost nothing but ETFs in it.

For a retail investor, the whole portfolio pretty much can comprise just ETFs?

It’s tough for me to come up with an exposure that an individual investor, certainly, would normally be looking for that they’re not going to get in an ETF wrapper.

Are there some things?  Sure, you can’t buy fine art in an ETF, you can’t buy wine in an ETF, you can’t invest in expensive, quarter-million-dollar watches in an ETF yet. So there are things at the sort of ultra-high-net-worth end of the spectrum that are in alternate buckets, that don’t have the liquidity. Non-traded REITs. …. Anything that requires accredited investor certification like private equity, farmland, things like that.

But for most retail investors those aren’t even on the radar and frankly nor should they be. The average retail investor who’s looking for a diversified portfolio that’s managed to their risk tolerance that includes a broad mix of global asset classes … the ETFs were designed to do that from day one.

Was this a watershed year for ETFs?

It’s tempting to say yes because it feels like a watershed year but I probably would have said the same thing last year and I probably would have said the same thing in 2017. 

The pandemic era, if you will, has been unbelievably bullish for ETFs as a structure. I think it’s also been a real renaissance for investors … this focus on investing as a thing that the average person in this country needs to pay attention to, because it’s how they’re funding their retirement, it’s how they’re funding their kids’ college education. … 

That focus does feel unique and strong this year. It does feel like this pandemic era really has just been an embarrassment of riches for the average investor, in spite of this year.

These kinds of reshuffling in valuations are actually really important opportunities for investors. The ability to get into bonds with meaningful yields for the first time in decades, that is a phenomenal opportunity. And for the first time honestly since the ‘90s an advisor who’s got clients in retirement can build a bond ladder and not get laughed out of the room. It’s been a long time since that’s the case. …

As painful as this year is, if you sit back and look at it objectively … nothing broke. That to me is the shocking thing … All the infrastructure is working perfectly. We’re not hearing about any broker closing down, a run on savings and loans or this corner of the real estate market is imploding or the inability to staff factories. …

Everyone’s actually working surprisingly well. Ninety-six percent of dividend payers kept their dividends flat or increased them in the third quarter, so yeah, the market may be down, the economy’s doing better than a lot of people think.

What do you see happening with ETFs in 2023?

In terms of innovations in the product structure, I’m not anticipating any big, giant, “Oh my gosh, we’ve never seen a product like that before.” There’s not a regulatory thing on the horizon or a bunch of filings that need to be approved that everybody’s waiting on tenterhooks for, which has been the case in many years. For years we were waiting for non-transparent active, we were waiting for bond funds. That all seems pretty settled.

Rule 6c-11 when we passed that a couple of years ago, really leveled the playing field and made the cavalcade of new and weird product launches slow down a little bit. I think that’s mostly good. (The SEC adopted this rule in 2019 to modernize ETF regulatory framework and facilitate greater innovation and competition in the space.)

So when we think about what’s important for ETFs next year, really what we’re asking is what’s important for the market next year, because really at this point, there is pretty much an ETF for almost any kind of exposure you want.

So what that means for the average advisor I think is going to be a continued look at alternative ways of implementing asset management in their businesses, whether that’s using a TAMP (turnkey asset management program) or a model portfolio provider or looking at direct indexing. So you’re going to see some refinement in the advisor community about how they deliver those results to investors.

We’ve definitely seen a big push from the major players on the direct indexing side of the business, which sort of lives alongside ETFs very nicely because direct indexing tends to focus on U.S. equity, then you fill out the rest of the portfolio generally using ETFs, so those all live nicely next to each other. I’m hearing a bunch about that from advisors more and more. And certainly this year with tax loss harvesting, direct indexing is having a bit of a moment in the sun, because for folks who have been in a DI platform for the last year or two, this is a big year in terms of single-stock tax-loss harvesting.

We’ll see more and more of that next year. Obviously markets are going to be continuing to react to the poly-crisis that we’re facing … There’s plenty of the crisis to go around for everyone and I don’t think any of those are going to resolve with a nice tight bow next year, so it’s going to be another year of the daily news cycle and it’s going to be a little exhausting. My general advice to people is step away from the screen a little bit more as opposed to figuring out how to solve it.

Do you see active ETFs getting a great share flow next year?

I’m not sure I see it blossoming to anything like 25% of flows but this sort of 10% to 15% of flows on an annual basis feels about right. 

For most investors the core of their portfolio should probably be low-cost passive beta, and usually that’s going to be in an ETF structure. Where we’re seeing more interest in activity on the active side …  people are using that as a satellite position to try to access a particular kind of innovation. You can see that in the edges of the bond market as well, actively managed high-yield bonds, things like that.

We’ll continue to see active managers find their spots. An interesting question that I don’t know the answer to is hat are we going to see from the rest of the active management community, meaning those folks who aren’t in ETFs yet, or have really just put a finger in the ETF market, like Fidelity probably I would say is not all in yet in ETFs, they certainly have a solid product line but they’re definitely still a mutual fund shop at the core.

We’ve seen folks like T. Rowe Price and American Century come to the market with pretty solid core offerings from their active managers, and JP Morgan as well. And when those products perform and when the stories are good, people gobble them up. 

JP Morgan’s JEPI, their equity income product, which is actively managed, one of the top asset gathering funds of the year, tens of billions of dollars flowing into that fund. I think we’ll continue to see success stories like that. 

Dinah Wisenberg Brin

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.