VettaFi Voices On: 2023 Predictions | ETF Trends

What do markets have in store for investors in 2023? The VettaFi Voices gathered around the Slack water cooler, consulted their crystal balls, and shared their predictions.

Todd Rosenbluth, head of research: Since I’m first, everyone will agree with me and we can go back to finalizing details for Exchange, the best conference of 2023, right?

I previously said it on “ETF Prime,” and now Nate Geraci is similarly predicting it, but: We will have $1 trillion of new money in the ETF market. We came close in 2021, with over $900 billion in flows, and we saw $611 billion in 2022, despite double-digit losses for many equity and fixed income benchmarks globally. Many people who have long used mutual funds are realizing now they paid a lot to have negative returns on stock and bond funds, then got a capital gain bill. Likely, they told their advisors, “We need to find something better.” They have been and will continue to shift to ETFs.

In addition, the liquidity [in the ETF market]has gotten stronger, making institutional investors more comfortable. In 2023, I think we will have another strong year for smart beta ETFs. In 2022, there were record inflows to alternatively weighted ETFs, including low-volatility ETFs like the Invesco S&P 500® Low Volatility ETF (SPLV) and the iShares MSCI USA Min Vol Factor ETF (USMV), quality ETFs like the Pacer US Cash Cows 100 ETF (COWZ) and the iShares MSCI USA Quality Factor ETF (QUAL), and equal-weighted ETFs like the Invesco S&P 500 Equal Weight ETF (RSP).

The market is likely to remain choppy as the Fed slows down rate hikes and companies struggle to generate earnings growth. ETFs that are tilted away from growth will perform well. I’m focused on multi-factor ETFs in particular, as many of them performed well in 2022 — examples include the iShares US Equity Factor ETF (LRGF), the Invesco Russell 1000 Dynamic Multifactor ETF (OMFL), and the SPDR MSCI USA StrategicFactors ETF (QUS). These can be a good replacement for people who want something like active management but who want to pay less and keep it simple. (Of course, they can still turn to active ETFs, like the JPMorgan Equity Premium Income ETF (JEPI), for equity income).

I also think we’re going to see a shift away from the ultra-short bond ETFs that were in favor in 2022, like the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL) and the iShares Short Treasury Bond ETF (SHV). Investors will move further out on the curve as the Fed looks to slow down and even stop raising rates in 2023. I see investors instead turning to more intermediate-term products, like the iShares 7-10 Year Treasury Bond ETF (IEF) and the iShares 3-7 Year Treasury Bond ETF (IEI), which are more rate-sensitive in a positive way for the new environment. Or buying active core bond ETFs, like the PIMCO Active Bond ETF (BOND) and the SPDR DoubleLine Total Return Tactical ETF (TOTL), which benefit from management’s ability to shift based on expectations of Fed action but find undervalued securities.

Dave Nadig, financial futurist: While the future is unknowable and predictions are a mugs game, I think $1 trillion in assets is pretty much in the bag, unless we have really malaise-filled markets for the entirety of the year. My combo platter of selected inputs and analysis (since I’m not an economist) is that we’re probably going to overshoot from a Fed policy perspective, and we should already have been done [with rate hikes]. Because (particularly) inflation and labor data is muddy and complex, there are plenty of signs for people to point to which support their own narratives, but my read is this: The labor market has softened and inflation has moderated more than the data suggests. (In both cases, the signs are there, but you have to get way under the hood.) That’s the reason so many of the endless “outlooks” for the year are talking about a first-half recession.

Other thoughts: I do think this is another good year for active flows, but the conversation is going to be much less about stock picking and much more about rethinking portfolio construction. Bond funds are going to proliferate (both literally, in terms of more funds being launched; but I also mean investors will use them more), and I think we’ll see a much better year for international securities of all sorts as the dollar cools off.

Rosenbluth: Nothing like the start of a new year for hopes that it will be a good year for international investing. But actually, the MSCI EAFE Index lost less than the S&P 500 Index in 2022 — not that most people are happy or even aware of it. But the dollar being less of a drag will be helpful for international stocks in 2023.

Nadig: One more thing — Todd, I do think there’s a lot of portfolio re-evaluation going on. It’s a constant topic with advisors I talk to: how to deal with home bias, how to deal with bonds, where to find diversification, etc.

Rosenbluth: Agreed, Dave, and I think that is what will help get to $1 trillion of net inflows. If investors are re-evaluating their investments, they might as well choose a cheaper, more tax-efficient approach in ETFs.

Stacey, do you think energy markets will remain tight in 2023?

Stacey Morris, head of energy research: I think energy stocks can continue working in 2023. Even with two years of strong gains, the space hasn’t become expensive. Companies are generating a lot of excess cash that is being returned to investors through buybacks and dividends. The impact of a recession on energy demand remains a risk, but I think energy markets will remain tight, supporting commodity prices.

Specific to midstream, I think it is a great energy subsector for income investors and for energy investors looking to ride out a recession. The fee-based nature of the midstream business model allows for stable cash flows, and midstream should be more defensive if the energy macro backdrop deteriorates. That is not my base case, but everyone’s crystal balls are different. Our 2023 midstream/MLP outlook goes into more detail on the macro picture and why we think there is still plenty to like about midstream. 

Rosenbluth: Does your outlook assume a recession that will slow oil demand, though?

Morris: Since you asked, I’m taking you into the weeds with me a bit! My outlook does not assume a recession driving oil prices materially lower. If there’s a deep recession, oil demand could certainly fall. (Typically, diesel demand is where you see the weakness, since it is more sensitive to overall economic activity. To connect the dots, lower diesel demand can cause refiners to lower utilization rates, which ultimately results in lower oil demand.)

However, there are a lot of factors that could offset potential demand weakness from a recession; China ramping back up, OPEC+ could cut supply to shore up prices, and Russian exports falling could also tighten the market. Keep in mind, Russia is a notable exporter of diesel, and the EU ban on Russian-refined product imports takes effect on February 5.

Potentially lower exports of diesel from Russia offset potentially weaker diesel demand. There’s so many variables around energy markets, which is one of the things I love about trying to analyze this space.

If there is ultimately less diesel supply on the market, then that could offset demand weakness from a slowing economy. In short, I think this recession could be different for energy, and I think commodity prices could hold up better than one would normally expect in an economic slowdown.

Rosenbluth: If getting in the weeds involves diesel demand helping offset Russia, then I am happy to go along and learn as well. What about the travel space, Roxanna?

Roxanna Islam, associate director of research: For travel, I think we could see an environment that looks a lot like 2019, despite current inflationary pressures. Even though consumers are feeling higher prices from gas, food, and rent, they’re still willing to spend on things like vacations and luxury goods. But I don’t think that necessarily means they’re eagerly throwing money into these items. Consumers are likely looking for ways to save money, which is another reason that I see e-commerce continuing to show strength this year. It’s easier for consumers to compare prices and shop for discounts online vs. in person, while retailers who haven’t already invested in e-commerce and omni-channel operations may find it valuable to do so in order to more effectively manage inventory and reverse logistics operations (i.e., returns and exchanges).

Rosenbluth: E-commerce trends you highlight would be good for ETFs like the First Trust S-Network E-Commerce ETF (ISHP), the Amplify Online Retail ETF (IBUY), and the ProShares Online Retail ETF (ONLN), right?

Islam: Yes, but while the demand is there, e-commerce stocks are heavily related to the tech industry. And I think investors are still somewhat fearful of anything growth or tech-oriented, especially with what we’ve seen happen to stock prices in 2022. But since stock prices are down by over 50% for some large tech names (and some are currently at record lows), investors may also see 2023 as a buying opportunity for investments they felt like they were “too late” to get in on. This could be broadly supportive to thematic ETFs, since many of them are heavily weighted to “MAANG” stocks and other tech constituents. We’re also still hearing a lot about layoffs, so I’m curious to see how many of these large tech/tech-oriented companies will actually be able to show some early improvement in their margins during 2023 and quell some of that investor reluctance to get back into tech or growth.

Rosenbluth: I see Lara Crigger is possibly trying to get the final word, but I’m still waiting to find out what she sees in her crystal ball.

Lara Crigger, editor-in-chief: Just captivated by the conversation, that’s all!

So I think the safest prediction is that, just like 2021 and 2022, we’ll continue to see active ETFs flood the market, regardless of whether or not investors are actually buying them. I highlighted this on Twitter, but active ETFs made up 235 launches last year, or 55% of all new ETFs.

Yet — and I have to tug on something Dave said upthread: Active ETFs aren’t quite punching at their weight class with investors. More than a quarter (27%) of the ETF market is made up of active funds now, but they only account for 5% of total AUM, and they only accounted for about 13% of total ETF inflows last year. Apologies for the numbers soup there, but the TL;DR is that issuers are launching more active ETFs than investors actually have appetite for.

Now, I’m pretty sure some of that’s selection effect at work. Most advisors only allocate to ETFs listed on their platforms, and most advisory platforms only add new ETFs that have crossed some AUM threshold (e.g., $50 million or $100 million) and which have been around for a certain number of years (often three or more). Most new ETFs don’t make it onto those platforms, and most new ETFs for the past two years have been active strategies — ergo, that means there’s a whole lot of active ETFs advisors can’t access and therefore can’t put money into.

That said, I think we see a lot of evidence that advisors are also waiting for the right active strategy to sprinkle into their portfolio — look, for example, at the success of JEPI, which added $13 billion in 2022.

Rosenbluth: Lara, let me repeat your numbers back to you but with a different spin. Active ETFs represent 5% of the asset base but pulled in 13% of the flows. Meaning, they are in demand. They’re not growing as fast as the supply is, but while JEPI and the Dimensional U.S. Core Equity 2 ETF (DFAC) are crushing it with limited ETF trading histories, it can take time for a new ETF to gain traction. Active ETFs will represent 10% of the ETF market in the next few years.

Crigger: I’d buy that. Like you, Todd, I’m keeping my eye on “active-ish” strategies in 2022, by which I mean funds like the Pacer Trendpilot US Large Cap ETF (PTLC) or the Fairlead Tactical Sector ETF (TACK), which might or might not be technically classified as active, but which use a rules-based methodology to make sophisticated, tactical toggles between asset classes or sectors. And in fact, those two ETFs saw big engagement jumps on the VettaFi platform in December.

I’d also put in that camp the iMGP DBi Managed Futures Strategy ETF (DBMF), which saw the highest year-over-year engagement increase of any ETF.

I think “active-ish” strategies will be the ones investors and advisors turn to in order to get them through the recession that the consensus is calling for. And they’re going to be sophisticated strategies, maybe using options or technical signals in their methodologies. Those of us in editorial are all going to have to get doctorates in statistics to keep up.

Rosenbluth: What’s your wildest prediction?

Crigger: Wild prediction: We’re going to see many more influencer-backed ETFs launch this year. Every Kim Kardashian and Jake Paul with a wide Insta-following and a dream is going to take a page out of Dave Portnoy’s book and launch their own ETF. We already saw a few come out this past year, including the Meet Kevin Pricing Power ETF (PP) and the Jim Cramer ETFs. More to come.

Rosenbluth: We will definitely see more ETFs tied to personalities, but will they have staying power? I doubt it. The Portnoy-related index fund, the VanEck Social Sentiment ETF (BUZZ), is down to $50 million in assets. And while I got the chance to meet Kevin, the mind behind PP, the fund has $11 million in AUM (albeit after just a month). The bar to launch an ETF is definitely lower than it used to be.

Hey, some of us have four letters only in our name. Maybe there can be a DAVE or a LARA ETF in 2023.

Lara Crigger: Don’t sleep on a TODD ETF! That seems like a surefire winner.

Be sure to catch the VettaFi Voices, as well as a host of experts, at Exchange, on February 5–8, 2023, in sunny Miami, Florida. To learn more about the event and register, please visit the Exchange website.

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