The late-year rally in stocks and bonds has created an opportunity for investors to re-evaluate their portfolios at a time when the ETF industry is cranking out new products in areas including active fixed income and, potentially, cryptocurrency. The best performing ETFs in any given year are ultimately a function of what’s happening in the broader markets. Investors should be sure to understand not just how a fund might perform in different market environments, but also how buying it changes their portfolio. That is especially true after the narrow market rally of 2023, which increased the concentration of the largest tech stocks in the S & P 500. That means that investors who buy into broad equity ETFs that are market cap weighted, or certain sector funds, would in some sense be doubling down on names like Nvidia and Meta Platforms . That could prove painful if tech stocks reverse course in 2024. “The tech-sector risk would appear to be twofold: meeting higher expectations, and whether meeting those expectations will be sufficient payment on 2023’s tab,” ProShares head of investment strategy Simeon Hyman wrote in the firm’s 2024 outlook . “Let’s make that three-fold by adding concentration risk: Apple, Microsoft and Nvidia account for over 50% of the tech sector’s market cap.” XLK YTD mountain Tech-focused ETFs like the XLK have outperformed the broader markets in 2023, but can be heavily concentrated in just a few companies. Investors may get the most bang for their buck by using ETFs to diversify into areas of the market that are less represented in their core portfolio. “We expect high-yielding, high quality ‘Prudent Yield’ credit assets to outperform bond benchmarks,” Bank of America ETF Strategist Jared Woodard said in a Dec. 6 note to clients. “In equities, investors should diversify with EM small caps, South Korea, and U.S. defense stocks. Gold and resource equities are attractive hedges,” he added. Some of Bank of America’s top fund ideas for the new year are the Vanguard Emerging Markets Government Bond ETF (VWOB) and the Invesco Aerospace and Defense ETF (PPA) . Bitcoin funds The most anticipated development for ETFs in 2024 is the potential arrival of spot bitcoin ETFs. The Securities and Exchange Commission has been meeting with asset managers about their applications for such funds, and a decision is expected in January. The involvement of major asset managers like BlackRock and the billions of dollars already invested in bitcoin through the Grayscale Bitcoin Trust (GBTC) , which could convert into an ETF, suggest that bitcoin funds could be a huge category. Excitement around the potential approval of a bitcoin ETF has helped bitcoin rocket back above $40,000 in the final weeks of the year, but there is still some skepticism among financial advisors about the final demand for bitcoin ETFs . BTC.CM= YTD mountain Bitcoin has broken back above $40,000, fueled by hopes that a new ETF will allow for new investors to buy into crypto. Active and fixed income A major source of change in the ETF market over the past year was active management, which became easier to do in an ETF after a 2019 regulatory change and finally took off in 2023. Active funds accounted for about 75% of new ETF launches and 25% of net flows in 2024, as of mid- December, according to John Hooson, managing director for Brown Brothers Harriman’s Global ETF Product team, rapid growth in an industry known for passive management. “I think active ETFs is where we’re going to see the growth. We certainly saw that in 2023. It still has a lot of room to catch up,” said Marlena Lee, global head of investment solutions at Dimensional Fund Advisors, which has found success with systematic active funds, or ETFs that largely track market segments but also have the flexibility to make small, discretionary moves. Some of the growth in actively managed ETFs has come from popular income-generating strategies that use options, like the massive JPMorgan Premium Equity ETF (JEPI) , while one of the year’s most successful fund launches, measured by net inflows, was the BlackRock Flexible Income ETF (BINC) , helmed by star bond manager Rick Rieder. Many industry experts see bond funds as a key source of growth going forward. “The flows that have kept mutual funds kind of going have been active fixed income,” said Bryon Lake, global head of ETF Solutions at JPMorgan Asset Management. “People still want active fixed income. … The leap of active in fixed income and getting that exposure to the ETF wrapper is where I think the game change is going to happen.” JPMorgan’s Ultra-Short Income ETF (JPST) is the biggest active bond ETF on the market, and the firm launched a longer-duration fund ( JBND ) in October. What’s next for cash? Bond funds could be well positioned to grow by attracting some of the more than $5 trillion sitting in money market funds, which will likely see some investors leave if the Federal Reserve cuts rates. Investors who want to keep a similar level of yield can try longer-dated bond funds instead. “We’re certainly hearing more conversations that are along the lines of I’m starting to leg back in to some portion of the fixed income market, whether it’s lengthening my duration on the ultra short side and then sort of jumping into the middle of the curve to go outm” said Noel Archard, global head of ETFs for AllianceBernstein. Archard’s firm launched five new fixed income funds in December . And of course, some of that money could go into equity funds too, particularly if investors feel burned by missing the recent rally. “Even with the higher short term yields, we do think that there’s an opportunity cost from not being invested in stocks or from not having a broader investment opportunity set in fixed income,” said Dimensional’s Lee.
