Despite a sluggish start to the year, a record number of product launches and a red-hot November have put 2023 back on pace to be a solid year for ETFs.
Total flows are on track to hit $500 billion — a far cry from the peak $900 billion in 2021 but, by many measures, still an impressive haul.
And with billions flowing into ETFs mimicking money market funds, two bright spots have been actively managed ETFs and short-term bond ETFs, as investors clamor to capture those tantalizing 5% yields.Â
Roughly $1 trillion has gone into money market funds this year, but some are questioning whether the solid year-end stock rally will attract some of those flows back into equities.
Ben Slavin, global head of ETFs at BNY Mellon, said investors have already begun putting their money where the market is. BNY Mellon is the largest asset service provider to the ETF industry — responsible for handling much of the custodial work behind creations and redemptions.
"That's exactly what we saw here in November," he told CNBC's "ETF Edge" on Monday. "You saw that enormous cash pileup going into money markets, and ETF flows were muted. Then, November comes and we started to see that money really come back off the sidelines."
More than $100 billion poured into ETFs in November, accounting for almost a quarter of the full year's $467 billion in total flows. And in a complete reversal from the first half of the year, ultra-short fixed-income ETFs suffered roughly $8 billion in outflows, with a large chunk being siphoned into equities instead.
Search for yield beyond money markets
Investors have been spoiled by a 5% yield, but as money-market yields start to come down, money markets will start to lose their luster. Right now, the stock market is poised to recapture a decent portion of those flows, as investors try to maintain a high current yield.
But a second factor could account for last month's blistering pace of inflows — tax-loss harvesting, which helps investors lower taxes by harvesting losses and using them to reduce their taxable capital gains.
Andrew McOrmond, managing director at WallachBeth Capital, said he sees the shift as a sign of confidence in the market.
"We talked about the money market funds," he said. "All of that is probably money that people took out of equities — even if they're just single-stock holders — because of a lack of confidence in the market besides the big seven. And now they're going to start to see it's safe to get back in the market."
McOrmond said he sees flows likely returning to dividend and high-yield equity ETFs, in particular. Â
"Rates will at least level off in the money markets," he said. "And the only way you're going to get [5%] is equity dividends or high yield. If you're going to go to fixed income, it'll go back to just the same trade we had two to three years ago."
He pointed to strong inflows into high-yield ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Bloomberg High Yield Bond ETF (JNK) and SPDR Bloomberg Short Term High Yield Bond ETF (SJNK) — along with dividend ETFs such as the Pacer U.S. Cash Cows 100 ETF (COWZ).
Broadening exposure beyond big-cap techÂ
Tech is another of the year's biggest trades. After piling into big-cap tech, many investors are now positioning themselves for a broader recovery in 2024.
Market bulls have been heartened to see money flowing into equal-weight gauges of the S&P 500, such as the Invesco S&P 500 Equal Weight ETF (RSP), which is up 8% over the past month, handily outperforming the market cap-weighted S&P index.
Slavin said advisors and clients alike were concerned about concentration risk from the mega caps and were seeking out lower-valuation plays.
"RSP is exactly one of those products where investors are looking for not just the Magnificent Seven, but those stocks that may be a little bit lower on the valuation end of the spectrum," he said.
Investors may also opt for the tried-and-true approach going into January of scooping up some of the year's biggest laggards — including small caps, consumer staples and energy — in a mean reversion play.
"If the whole market rallies, I don't think tech [stocks] can keep the same lead they had before," said McOrmond. "I wouldn't suggest short tech, long value ... but if the overall market rallies, I think that gap will close."
Crypto ETF impact?
Finally, crypto has had a tumultuous year, but the crypto community is now hoping for the nation's first-ever spot bitcoin ETF to get approved. So far in 2023, the price of bitcoin has rallied 30%, partly on hopes of a bitcoin ETF, which many are anticipating will get the regulatory green light in January.
More than a dozen issuers are waiting in the wings for their proposals to get approved, and the question now is whether it will spark a new wave of interest in the ETF space.
