Watch for These ETF Trends in 2023: Dave Nadig

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.