On the first 2023 episode of ETF Prime, host Nate Geraci and Dave Nadig, Financial Futurist at VettaFi, previewed the upcoming year in ETFs and the financial markets. Nadig also discussed the potential implications of longer-term asset management trends including crypto, ESG, direct indexing, and the rise of passive.
After taking a moment to catch up, Nadig and Geraci started off discussing the upcoming Exchange conference, which kicks off February 5th through February 8th at the Fontainebleau in Miami Beach. “Really excited for some of the things we’re going to be able to put on stage down there,” Nadig said, with Geraci noting that ETF Prime will record live at the event.
Looking Into the Market Crystal Ball
Coming off a year where the S&P was down 18%, bonds were down 13% and just about every asset class, save commodities, was down on the year. 2022 cracked just about every crystal ball out there (while also pouring gasoline onto tarot decks and lighting them ablaze for good measure).
That said, because predictions remain fun and useful thought experiments, Geraci and Nadig made a few for 2023, fully anticipating some of these as not coming true.
Fed Up
Nadig started off by looking at consensus, with numerous end of the year pieces coming in all agreeing that the first half of the year will be soft, the Fed will have to pivot, and the markets will recover at the end of the year.
Geraci expressed concern that the Fed could be crushing demand when there are some real supply side issues that haven’t been resolved.
“I think there are plenty of folks out there that I respect who believe the Fed has already made a policy error, has already been too aggressive for too long,” Nadig concurred. He thinks the consensus could be right, with a soft early year that sees inflation prints tracking in the proper direction but more data showing the labor impacts of rising rates. Despite generally agreeing with consensus, Nadig noted “I’m skeptical on rate reductions in calendar year 2023.”
Investor Plays
Despite the bumpy 2022, no investors ran to cash. Nadig articulated that this is because, when it comes down to it, there is no alternative – U.S. investors have been conditioned from such a long stretch of no rates to invest in stocks. “That has been beaten into heads of millennials and Gen-Xers for decades at this point. The irony is its less true than its been in 30-40 years.” Nadig thinks portfolio products, hedging and rate-based products, and more will start to see their time in the sun.
Making what he described as a “wussy” call, Geraci said, “I expect bonds to make a big come back this year.” Gold is also compelling, according to Geraci. Gold “typically marches to the beat of its own drum,” he said, pointing out that the fall of crypto could help make gold more attractive as the “tried and true” store of value.
Nadig is more skeptical on gold. A strong dollar makes it tough to put together a case for gold to get a huge lift, as Nadig observed, “I don’t think it peaked over $2,000 more than once or twice through the entire crisis period during the pandemic.”
Record Breaking Inflows, Trades, and Launches
2021 set the high-water mark for ETF inflows, but in some ways 2022’s performance was even more remarkable. Despite the challenges facing the markets, ETFs had $600 billion in inflows with enormous trading volume and numerous product launches. Asked if the $900 billion record from 2021 could be topped, Nadig said it is not only possible, but likely. “This is largely a reconfiguration year,” Nadig said, with advisors and investors looking at how they want to position amid a year that is likely to be less dramatic than the previous one. “That lack of drama is great for inflows because it means lots of folks are going to be looking at their statements.”
A trillion dollars is completely possible, barring any sort of hiccup. Nadig saw potential danger in the ETF space if the market becomes weird and idiosyncratic and keeps changing up rapidly enough to burn hands and exhaust investors.
“Just think about how dormant the fixed income side of the ETF balance sheets have been for so long,” Nadig observed, noting that lots of interesting bond funds have recently launched and look well positioned to hoover up more flows in 2023. “I do think fixed income is going to be the story of the year.” New, innovative products could help further boost fixed income’s ETF ascension.
Factor Based Resurgence and ARK Comeback?
Though not suggesting that the smart beta heyday have the 2010s is coming back, Nadig did suggest that factor-based ETFs might see a resurgence given some of the strong numbers they put up.
ARK’s flagship fund, the ARK Innovation ETF (ARKK) had a performance year to forget despite continuing to garner inflows as investors doubled down on the fund. Geraci asked Nadig what ARK’s future will look like, and Nadig offered that getting kicked in the teeth comes part and parcel with innovative technology. Their Tesla positioning aside, under the hood ARK is still looking for disruptive companies that have great ideas. They aren’t simply doubling down on what they already have, but looking for the next big thing. “The question is going to be timing. I actually suspect they’ll get the calls right,” Nadig said, the question will be timing their calls and getting into the right companies at the right time.
Morgan Stanley Moves in 2023
Morgan Stanley could make moves into the ETF space. According to Nadig, “In two to three years we may be talking about them being in the top 10 and rising.” With $5 trillion in wealth and distribution networks galore, both Geraci and Nadig see Morgan Stanley as a future big player in the ETF space.
The 60/40 Portfolio’s Death Has Been Exaggerated (Or has it?)
VettaFi’s Lara Crigger predicted on the last episode of ETF Prime that the 60-40 might be over, causing quite a stir. Nadig said he agrees with Crigger, but not in the way that many interpreted her comments. “It’s not that 60/40 is dead because that asset allocation is a bad idea. I think it’s the idea that you can come up with this abstraction that that’s monolithic and say that this is an accurate benchmark for the average portfolio is silly.” Nadig expressed that there are multiple ways to slice and dice an allocation. U.S. equity allocation vs non-home bias allocation? What are your two or three-rate positions? What are your non-correlated assets? He noted that funds like Cambria Trinity ETF (TRTY) don’t own a 60/40 portfolio. It owns a complex portfolio with a variety of assets in it. Funds like the iMGP DBI Managed Futures Strategy ETF (DBMF) also had killer years, paving the way for more complex uncorrelated products and alternatives to grow in 2023, even though it might be six months too late to ride the alt wave.
2023 Crypto Clues
Asked if a crypto comeback is possible in 2023, Nadig said he doesn’t believe that we’ll see the advisor space have a ton of hype for it. He thinks that there’s been a crypto recalibration. Though quick to assert that he feels bad for people who lost money or got hoodwinked in the FTX debacle, Nadig said he’s bullish on what this space could bring and sees potential opportunity in this recalibration of the space. “It makes it easier to innovate because it lowers the temptation for these kinds of grifts.”
Nadig doesn’t see a Bitcoin spot ETF in 2023, but does think that there will be some interesting events with the GBTC SEC lawsuit and Valkyrie’s long shot shareholder takeover bid of GBTC.
Looking past 2023, Nadig thinks they will be playing in a sandbox for a couple of years before building up the necessary regulations and protections. He doesn’t see it as happening in this congress or even this presidency, but possible in the one after it. Afterward, there are a number of reasons to get excited about what cryptocurrencies can lead to and do on their own. “I think we can head towards a world of tokenized asset management where we get to choose the appropriate ways the system works and not just stumble into it, but we need that bridge.”
ESG
Pivoting to the future of ESG investing, Nadig said, “I’ll keep point out that the ESG versions of the S&P 500 have beaten the S&P 500 for every holding period you want to bother and go look at for every holding period starting today and going backwards.”
Though U.S. investors became hesitant on ESG and flows were largely flat, global investors remain highly interested and are pouring money into ESG funds. “It is simply the way the world is heading and the U.S. gets to decide how much we care.”
Direct Indexing
As direct indexing proliferates, Nadig reinforced that it won’t be an ETF killer, but could be a useful tool for investors. “You aren’t simplifying your life, you’re making your life much more accurate. That requires time and energy,” Nadig said, pushing back against the idea that direct indexing will simplify everything.
The Rise of Passive Investing
Investors continue to put money to work in passive products. “We live in a world where information about companies is now disseminated quickly and violently absorbed into prices that is frankly shocking sometimes,” Nadig said, continuing, “but at the same time, absent that, the drumbeat of the markets is going to be up and to the right.”
Geraci argued that the swingy nature of the passive market just means active managers can set prices faster.
Nadig thinks it’s healthy to question the impacts of what you are doing, however, saying “what are we missing and would it provide some systemic instability? That is a question we should ask about passive every day. It’s a question we should ask about crypto every day.”
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