Four ETF Trends to Watch in 2024: Part 2

As the U.S. ETF industry crosses the $8 trillion asset threshold to close out this year, we look ahead to potential trends to monitor in 2024. In the first of this two-part series, we identified the ‘unbundling’ of emerging markets exposure and increased competition in active bond ETFs as trends to track. In this second piece, we examine additional developments to monitor next year. 

Trend 3: Continued Growth in Options-Based ETFs 

One of the defining features of the ETF industry has been the innovation in taking institutional strategies and democratizing them by making them available to retail investors. A notable example of this in recent years is options-based strategies. One popular category is covered call strategies like the JPMorgan Equity Premium Income ETF (JEPI), which uses call writing to generate premium income. Another is buffer (also referred to as defined outcome) ETFs, which allow investors to protect their downside risk in exchange for capping their potential upside. 

As shown in Figure 1, the number of ETFs using options-based strategies has increased dramatically in the last four years. An important driver has been the asset gathering success of JEPI, which took in $12 billion of new inflows in 2023 through December 18, putting it in the top 10 on the U.S. ETF flows leaderboard. Another factor driving new launches has been the success of firms like Innovator Management and First Trust in growing their buffer ETF product lines, which has encouraged other firms to enter this category. 

Figure 1: Number of ETFs in the U.S. using Options-Based Strategies

Source: CFRA ETF Database; Data as of December 18, 2023.  

The concept of covered call strategies in an ETF wrapper is not new, with the Invesco S&P 500 BuyWrite ETF (PBP) dating back to 2007. However, it was the stunning asset gathering success of JEPI during the market downturn of 2022 that brought attention to this space. Interestingly, that asset gathering momentum continued in 2023, even though covered call strategies tend to underperform in a rapidly rising market. This indicates that income-oriented options-based ETF strategies may have long-term staying power in sustaining investor interest. This will be put to the test in 2024 if the current market appreciation trend continues. 

The defined outcome category also sustained asset gathering momentum in 2023, even though these strategies should be most attractive in declining or flat market conditions. Defined outcome ETFs took in a robust $12 billion in net inflows in 2023 through December 18, with First Trust and Innovator Management as the leaders with $6.6 billion and $4.3 billion of flows, respectively. Table 1 lists the largest ETFs in the U.S. by assets in the covered call and defined outcome categories. Looking ahead to 2024, it is likely that options-based ETFs will grow as a category. 

Table 1: Largest Covered Call and Defined Outcome ETFs in the U.S. 

Source: CFRA ETF Database; Data as of December 18, 2023. 

Trend 4: Momentum in Tech and ‘Risk On’ Themes 

In 2023, investors rotated heavily into money market funds in response to higher yields and the equity and bond downturn of 2022. As of December 13, 2023, there were $5.8 trillion in U.S. money market funds, according to data from the Investment Company Institute (ICI). Given the equity market rally in 2023 and the likely pivot to rate cuts next year by the U.S. Federal Reserve, we may see investors move money out of cash-like instruments and migrate back to 60/40 portfolios by increasing their equity exposure. A key question will be which equity sectors or themes will be strong next year given recent market conditions. 

A sectoral analysis of past market cycles by Sam Stovall, CFRA’s Chief Investment Strategist, shows that when exiting ‘down’ years, it has historically been better to rotate quickly into the worst performing sectors as the market rebounds. We saw this recently when the worst performing sectors of 2022, like technology and communications services, were the best performing in 2023. However, when exiting ‘up’ years like 2023, investors are generally better off letting their sector winners ride. Past trends do not guarantee the future success of this strategy, but given this context and the easing of rates and inflation, it seems likely that ETFs oriented toward technology and communication services will continue to have a strong 2024. 

Table 2 summarizes the best performing ETF sub-categories of 2023 year to date through December 18, excluding leveraged and inverse ETFs. The best ETF performers have been tech and growth-oriented themes like fintech, cryptocurrency, metaverse, semiconductors, and software. These themes may continue to have a strong 2024, although this is likely to be accompanied by high volatility. 

Table 2: Best Performing ETF Sub-Categories in 2023 Year to Date

Source: CFRA ETF Database; Data as of December 18, 2023. 

One concern for investors is whether ETFs linked to sectors like technology can continue to appreciate in 2024. Analysis by CFRA’s fundamental equity analysts indicates that the largest tech firms have strong balance sheets and cash flows and are safe havens with a growth tilt. So, in the view of CFRA’s equity analysts, despite the AI-driven recent run-up, the tech sector is still growing into its multiple, and ETFs like the Technology Select Sector SPDR Fund (XLK) do not yet have frothy multiples. Table 3 lists the key holdings of XLK and the Communication Services Select Sector SPDR Fund (XLC), as well as CFRA’s current analyst ratings on them. We expect the recent strong performance of tech and growth driven ETF themes to continue in 2024, although with higher volatility. 

Table 3: CFRA Analyst Ratings on Top Holdings for XLK and XLC

Source: CFRA ETF Database; Data as of December 20, 2023.